Prologis Inc (PLD) 2020 Q3 法說會逐字稿

Welcome to the Prologis Q3 Earnings Conference Call. My name is Carol, and I'll be your operator for today's call. (Operator Instructions) Also note, this conference is being recorded. I'd now like to turn the call over to Tracy Ward, Senior Vice President of Investor Relations. Tracy, you may begin.

Thanks, Carol, and good morning, everyone. Welcome to our Third Quarter 2020 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, 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 SEC filings. Additionally, our third quarter results press release and supplemental do contain financial measures such as FFO and EBITDA that are non-GAAP measures. And in accordance with Reg G, we have provided a reconciliation to those measures. This morning, we'll hear from Tom Olinger, our CFO, who will cover results, real-time market conditions and guidance. Hamid Moghadam, Gary Anderson, Chris Caton, Mike Curless, Ed Nekritz, Gene Reilly and Colleen McKeown are also here with us today.

And with that, it's my pleasure to turn the call over to Tom. Tom, will you please begin?

Thanks, Tracy. Good morning, everyone, and thank you for joining our call today. Our third quarter results were strong as the team on the ground executed extremely well in this COVID environment, demonstrated by our operating performance and robust capital deployment activity.

Our results plus continued improvement in market conditions have upgraded our outlook. Starting with our view of the markets, our proprietary data reveals that operating conditions are meaningfully better than they were 90 days ago, and as a result, our earnings are now ahead of pre-COVID levels. The Prologis IBI activity index rebounded sharply to more than 59 in September, above our long-term average and up from 50 in June.

Space utilization, which is based solely on data source from our customers was 84% at quarter end and indicates our properties are returning to near peak capacity. On a size adjusted basis, lease signings were up 31% in the third quarter and up 4% year-to-date. Customers continue to make decisions faster than ever with lease gestation less than 50 days. Proposals remained at healthy levels, up 3% sequentially and up 12% on a year-to-date basis.

This positive momentum has led us to raise our market forecast. For 2020 in the U.S., we now estimate net absorption of 210 million square feet and completions of 295 million square feet, each up approximately 50 million square feet from our prior forecast. Net absorption in the quarter was robust at 65 million square feet, pointing to a very healthy finish to the year. We've also upgraded our year-end vacancy forecast for Europe and Japan to 4.3% and 1.3%, respectively. Notably, vacancy in Tokyo reached an all-time low of 50 basis points and rents are growing as a result.

As we look to space side, demand broadened across segments this quarter to include 100,000 square feet and above. Spaces under 100,000 square feet in several markets, notably the San Francisco Bay Area have lagged the other segment sizes in both occupancy and market rent growth.

For customer segments, demand is also broadening and diversifying in our portfolio. E-commerce continues to grow, representing 37% of the new leasing in the quarter, well above its historical average of 21%. The dramatic structural shift to online shopping is generating demand in 3 ways: first, a wide range of omnichannel and pure online retailers are growing. And while Amazon is very active, particularly with build-to-suits, they represented just 13% of our new leasing. Second, 3PLs represented more than 1/3 of new e-commerce leasing in the quarter, a record as customers race to augment their fulfillment networks. And third, many of the parcel carriers are also expanding their networks.

Our other segments represented 63% of new leasing in the quarter. The most active segments support essential industries, including food and beverage, health care and consumer products. Another new emerging structural driver is the need for resilient supply chain and higher inventory levels. Inventory-to-sales has fallen to the lowest levels on record, and many customers are operating with razor-thin inventory. We see signs that restocking process has begun.

Moving to our results. We had a strong third quarter with core FFO per share of $0.90. We outperformed our forecast due to higher NOI strategic capital revenue and termination fees, partially offset by slightly higher G&A.

Rent change on rollover continues to be strong at 25.9% and led by the U.S. at 30.7%. Rent collections remain ahead of 2019 levels. As of this morning, we've collected over 99% of third quarter rents and over 94% of October. In addition, we've received 95% of deferred rents due to date. Bad debt is trending lower than forecast and was 43 basis points of rental revenues in the quarter. This was roughly half of what we had forecasted. Our share of cash same-store NOI growth was 2.2% despite the impact from lower occupancy and bad debt.

This speaks to the underlying strength of our rent change, the primary driver of same-store growth in the quarter and the long term.

Looking to the balance sheet. We continue to maintain exceptional financial strength with liquidity and combined leverage capacity between Prologis and our open-ended vehicles, totaling more than $13 billion. We also continue to refinance debt opportunistically, setting records in the quarter for the lowest REIT and third lowest U.S. investment-grade 10- and 30-year coupons in history.

For strategic capital, investor demand is unabated Our team raised over $800 million of new equity this quarter and the queues in our open-ended vehicles currently stand at $2.6 billion.

Turning to guidance for 2020. Our outlook continues to improve, given what we see in our proprietary data, our customer dialogue and lower bad debt. While there may be headwinds until we put COVID behind us, our revised guidance range has taken that into account.

Here are the key components of significant guidance changes on an our share basis. We're narrowing our cash same-store NOI range to between 2.75% and 3.25%. At the midpoint, this assumes a 25 basis point reduction of bad debt with a new range between 45 and 55 basis points of gross revenues.

Globally, market rents grew in the quarter, and we now expect growth of 2% for the year, approximately 250 basis points ahead of our prior forecast. After prioritizing occupancy for most of the year, we've resumed pushing rents in a handful of leading markets, including New Jersey, Pennsylvania, Southern California, Dallas and Northern Europe as well as the 3 regional markets.

On the other hand, we're still solving for occupancy in Houston, Denver, West China and Madrid. Our in-place market rent spread now stands at over 12% and represents future incremental organic NOI growth potential of approximately $450 million annually. For strategic capital, we expect revenue, excluding promotes, to range between $380 million to $385 million.

The revenue growth for our business has been excellent. With a 5-year revenue CAGR, excluding promotes, of over 16%, the vast majority of this revenue is derived from recurring asset management fees from our perpetual or long life vehicles. When we look at multiples being ascribed to this business, our view is that they are far too low.

For comparison, public asset managers are valued at a multiple of more than 20x on far less sticky AUM with much higher promotes. For development, we expect to start $1.1 billion in the fourth quarter with the full year ranging between $1.6 billion and $2 billion, up $800 million from our prior forecast. Build-to-suits remain elevated and comprised about 45% of the annual volume. In addition, by year-end, we expect to restart about $180 million or approximately half of the development projects we suspended in the first quarter. At the midpoint, we are increasing both contributions and dispositions by $350 million. Based on our third quarter valuations and current market activity, pricing for our properties is now pushing well beyond pre-COVID levels.

Taking these assumptions into account, we are narrowing our range and increasing our 2020 core FFO midpoint by $0.045 to $3.76 to $3.78 per share. This includes $0.21 of net promote income, which is up $0.01 from our prior guidance. Year-to-date growth at the midpoint, excluding promotes, is 13.7%, while keeping leverage flat. Interestingly, while there's been a lot of noise over the past 7 months since the beginning of the pandemic, the net of it is, we're ahead of our pre-COVID earnings expectations today.

In closing, our performance is a testament to the foundation we've been building for more than a decade. Our 3-year earnings CAGR of 11% has outperformed the other logistics REITs by more than 500 basis points annually despite a greater relative decline in leverage. The work that we've done to create the best-in-class portfolio and balance sheet is clearly paying off. The business is proving to be incredibly resilient and is delivering exceptional growth which we expect to continue. With that, I'll turn it back to the operator for your questions.

(Operator Instructions) Our first question comes from Emmanuel Korchman from Citigroup.

Tom, just in terms of collections, they're obviously strong and they continue to be strong, but there is a downward trend. Is there anything specific in those numbers that we should be mindful of? Or anything that you think might drive a quicker recovery there than we're looking for or expecting?

Yes. Yes, Manny, collections have been excellent. Actually, there's no downward trend. If anything, they're trending up.

If you look at our collections today, we're at over 94% this morning. When we had a call in Q2, July collections were at 92%. So we're 200 basis points plus ahead of where we were comparably.

We're ahead of 2019 levels across the board. And I think collections are actually accelerating a bit from the last quarter. So I'm very, very pleased with where collections are.

Our next question comes from Derek Johnston from Deutsche Bank.

So lease spreads continue to be robust even as we progress through COVID-19. How do you view the pandemic's impact on the portfolio in terms of rent growth?

So when you look at the overall portfolio, do you believe you could have pushed rents harder without the pandemic? Or has the pandemic perhaps propelled rent growth? And then lastly, do current rent trends have legs in your opinion?

Derek, it's a good question and one that we ask ourselves often. But there's no going back and sort of playing that hand again because when you're looking at -- you're sitting there in March and looking at what could happen, you make certain decisions. I think, generally, we could have pushed rents harder had we known how this was going to play out, but of course, we didn't. I think that is gas in the tank for the next 12 months. So I'm really optimistic about our ability to continue to grow rents. And we turned over 15%, 16% a year.

So if we were a quarter or 2 late on pushing rents by a little bit, by the time you work through that 15% and a little bit of rent growth change, the numbers become miniscule in terms of what we may have missed. But whatever that was, I think, is fuel for future growth.

Our next question comes from John Kim from BMO.

This quarter, you had sequential occupancy decline at 200 basis points in both Chicago and Houston. I'm assuming this is based on new supply, but just wondering if that was the case, and also are there other markets where you're concerned from a supply perspective?

Yes, it's Gene. I'll take that and others may pile on. Houston, for sure, is going to face headwinds. There's a ton of supply in that market. And you guys know the story there. Chicago, we feel a little bit better about. Actually, that market is fairly strong. And elsewhere in the U.S., from a supply perspective, things actually look pretty good. We have seen in this quarter a significant increase in absorption and a corresponding increase in supply, but we're dealing with very low vacancy rates across the board. So we actually feel pretty good. And in the U.S., Houston would be the concern on supply at this point.

Our next question comes from Jamie Feldman from Bank of America.

Tom, you talked about $13 billion or so of liquidity. Can you help us understand or just think through what -- if there's any opportunistic acquisition out there where you might be able to put some of that capital to work over the near term?

Thanks, Jamie. Listen, I think we're -- the key for us is, for an opportunity, it's going to have to expand our growth potential. And it's -- when those things occur, it's hard to determine. But we're always ready. We always maintain significant liquidity. So when the time is right, we're ready to go. But we're certainly not seeing large portfolios on the market these days. We -- the pricing for our product is going to be well above where we were pre-COVID. So there's a lot of interest for product.

Our next question comes from Blaine Heck from Wells Fargo.

Tom, you noted that you guys are assuming starts of a little bit more than $1 billion at your share in the fourth quarter. Can you guys just talk about how much of those are built-to-suit versus spec? And whether this is just pent-up demand from clients that didn't want to pull the trigger earlier in the pandemic? Or what else is kind of driving your confidence to start that much in the fourth quarter?

I'll start with that question. I'll kick it over to Mike. But if we -- it's probably good to talk about spec development overall and what our picture looks like. So as a reminder, we suspended 16 projects in the spring in 18 markets, and that was almost $400 million of activity. And through last quarter and what we expect in the fourth quarter, we'll restart 10 of those projects and about half that volume. So we're generally positive on speculative development. And if you look at the next quarter, we will start more spec projects, somewhat less than we would have anticipated in January. But pretty close to those volumes.

So we will be down slightly with respect to spec development during 2020 versus the January forecast are actually up significantly with respect to the build-to-suit volumes. So that's where it's coming. And Mike, he'll probably add some color on that.

Yes, Blaine, let me add to that. We saw a really strong Q3 in terms of build-to-suits, particularly in Europe, with 6 projects starts there across diverse set of customers. And our overall prospect list, you heard us say this last time, it's probably a little bit shorter than it's been in the past, but the prospects on that list are as active and moving as quickly as we've seen in a long time. In fact, I've never seen anything quite at the pace. And of course, Amazon is a big part of that, but certainly not all of it. And there's quite a bit of activity in the structural changes that were announced by the home improvements, the food customers pre-COVID that they're now acting on at a quicker pace than even anticipated. So we're confident in the diversity of our build-to-suit pipeline and the strength of it.

So we're optimistic for the fourth quarter.

Our next question comes from Nick Yulico from Scotiabank.

This is Sumit for Nick. Thank you guys for putting together some great research on the retail conversion opportunity. I guess I'm interested if you could share your insights regarding why the freestanding retail component that you guys estimate at 40 million square feet of conversions or 50 bps to 150 bps of your market share, why is it so little when these are located in more densely traffic routes as well as are more supportive -- have more supportive parcel sizes, just to give you -- I think one of your developments in the Bronx is built over a 2 big acre lot, which is far less than the 5 to 6 acres that is typically required. So shouldn't this support more conversions across other areas? And honestly, putting full conversions aside, what drives your conviction that tenants could actually just plain lease-up these boxes? And or other nonperforming shopping centers for smaller delivery operations? Any color or any insights from your tenants would be great.

Sumit, it's Chris Caton. Thanks for the question. First, for those who aren't familiar what he's talking about, Prologis Research published a paper on prologis.com. We sized the retail to logistics trend. We estimated it being 5 million to 10 million square feet per year over the next decade. And this amounts to really a small part of our overall business, less than 5% than Last Touch, less than 1% of the existing logistics real estate facilities, for a lot of reasons.

So Sumit focused on the freestanding retail, that is, in fact, the largest category, and so that is where we expect to see the most conversion opportunities. But look, the challenges are many and varied in terms of the conversion trends, whether it's physical and the ability simply to use this site, whether it's economic and rents versus development cuts and higher and better use opportunities, whether it's local politics or whether it's just a legal situation at the site.

Yes. The other thing I would add to that is that in freestanding retail by and large is a more western and southern phenomenon because by definition those cities are less dense. And actually, that's kind of not where you want to have freestanding and Last Touch retail, you want to have it in dense metro areas. And if somebody's got a retail box in that metro area, they're likely to be doing pretty well with retail on it anyway. So it's sort of a catch 22. The places where you can find these boxes are not the places that there is heavy-duty Last Touch type of demand. The trick is getting the availability and the demand picture in the same spot.

Our next question comes from Vikram Malhotra from Morgan Stanley.

Just to build off a question on leasing spreads. You alluded to the fact that you've sort of extended the trajectory into next year. I'm just wondering if you can give us your updated thoughts on actual market rent growth in some of the key areas in the U.S., but also maybe in some of the global markets. Just wondering if all the factors you laid out has potentially accelerated that trend as well into '21 in terms of actual market and growth?

Vikram, thanks for the question. So as Tom shared in his remarks, global rent growth is on pace for 2% this year on a Prologis share basis, higher than that in the U.S., roughly flat in Europe and the U.S. and better than that, call it, 1% in Japan. That's a good number for Japan. Now what that looks like in 2021? We don't disclose the numbers, but what I do think about are the headwinds and tailwinds for our business.

And to an earlier question, these trends suggest an improving trajectory for rent growth. When I think about the positives for our business, I think about low vacancy in a lot of markets around the world. The structural drivers that Tom outlined in his script are really revealing themselves, both e-commerce and inventory levels.

We've seen positive momentum in the third quarter and solid proprietary data and there is this potential decline in COVID uncertainty COVID economic weakness. And you got to set that against the lack of clarity on COVID and some of the challenges that are intended with a recession that will play out in 2021.

Yes. But in terms of implications of rent growth on earnings, I mean, basically, rent growth globally this year is a little over 2% and probably 2.5% in the U.S. unless something really strange happens, I expect that number to be pointed up. Now how much up? In the last 5 or 6 years, we've always underestimated rental growth. So I don't know. But the primary driver of earnings growth is going to be mark-to-market anyway, whether on the margin rents grow 3% or 4% or 5%, that incremental amount, at least for the next year or 2 is not a big determinant of earnings growth. So I'm not trying to duck your question. I'm just -- given the kind of small changes we're talking about here, I don't think the earnings implications are significant.

Our next question comes from Steve Sakwa from Evercore ISI.

Just 2 quick questions here. Tom, I guess you pretty much raised all the metrics in the press release with the exception of same-store NOI growth. But you book -- your bad debt expenses down against quarter. Is the headwind here just some short-term issues on occupancy, number one? And then I guess just as it relates to development to me, to the extent that the e-commerce trend does continue, and it looks like it's going to continue to go up towards probably the mid-20s. How long and sustainable do you think the development pipeline can stay over $2 billion given the -- it seems like the growing demand pipeline you've got from not just e-commerce, but other categories that Tom mentioned.

Steve, I'll take your first question. So what's happening with cash same-store is flat at the midpoint, and it's all timing because we have significantly high leasing in both the second and third quarter, and new leasing was significantly higher. And as a result, what you're seeing is free rent from all of those lease commencements really hitting Q4.

So that's a little bit of a danger of using cash same-store here is because of that free rent. It's just kind of hitting in Q4. You'll note that GAAP same-store went up 25 basis points, commensurate with bad debt. So it's really a timing issue from that initial drag on cash same-store from free rent.

I think with respect to the legs of e-commerce and their effect on development going forward, I would still say we're in the very early innings of that in the long term. And I think as long as we're in COVID, the growth rate of e-commerce is going to be very, very significant. But as we come off of COVID, I expect that to take a little bit of a pause. It still will be at a very elevated level compared to where it was below COVID and it will start growing off of that elevated level. But I think it will take a pause because I think a lot of people will just want to get out and get somewhat back to normal.

But we, in effect, had a reset in the demographics that really is involved with e-commerce, because a whole generation of people that before was everything analogs are now used to doing things digital. With this exception of wanting to get out in the short-term and do some of the things that they've missed doing. But if we could go back and figure out where e-commerce was before COVID, and where it's likely to grow off of post-COVID, I would guess there's an 8% or 9%, maybe 10% change between those 2 levels pre and post-COVID. So we got more than 5, maybe 7 years of e-commerce penetration that is -- that will be sustainable as a result of COVID.

Our next question comes from Caitlin Burrows from Goldman Sachs.

Just maybe on the customer retention pricing side, customer retention was 73% in the third quarter, which is the lowest since, I think, the end of 2018. So could you just talk about some of the drivers of that? Was it tenants impacted by general economic uncertainty, customers moving for more space, a result of your own stance pushing price? Or what some of the factors of that retention metric were in the third quarter?

Let me take a stab at that, Caitlin, because that's a really interesting question. I think you've heard many, many times from different people that this economic recovery is sort of a K-shaped. There is a world of haves and the world of have-nots and relatively little in the middle compared to the most other periods. Well, both of those things on the two extremes will drive retention down. But the companies that are doing really well and expanding their business need more space. So by definition, they can't stay in the same space and need to procure new space. And the companies that are at the bottom of the K are going out of business or doing poorly, so they're going to get back their space. So I think as long as we are diverging from the middle for some period of time, you'll see declining retention, together with the fact that we're pushing rents more than we were in Q2, certainly Q2 now, and that's likely to drive retention downwards. But having said all that, as large as our portfolio is of 1 billion square feet, once you go through how much of it quarterly turns, which is about 40 million feet, 1 or 2 leases can move that percentage around between 70 and 80 pretty significantly. So I don't get that excited quarter-to-quarter. I look at trailing 4 quarters as an indicator. And if you look at that, our numbers have been forever sort of anchored around 75%, a little higher and a little lower, but around that average.

Our next question comes from Eric Frankel from Green Street.

Just first, can you comment on China's portfolio occupancy? Obviously, it's a small part of your portfolio, but it's obviously quite the opposite here it's quite different from the rest of your portfolio. And then second, I certainly agree with you that property values are higher than they were in the pre-COVID days. But maybe can you comment on the difference in valuation between your larger global markets or the regional market and whether you think there's a good -- a big valuation difference at this point?

Okay. Let me take a stab at both questions, and Gene may have more comments certainly on the second one. China occupancy is concentrated in Western China, in Chengdu and Chongqing. And as you know, it shows the operating metrics in a big way, but in terms of our share, it's actually a pretty de minimis kind of number. Having said that, the way land allocations work in China is that a city opens up, they allocate a bunch of land, and they put a requirement on you that you have to start construction in 2 years. And that obviously does not allow development to be matched with the demand easily because you have this sort of forced development starts that they impose on you for giving you that scarce land.

So that happened on a number of projects in Western China that we kind of were forced to start all at once. And that went right into when China shut down. And as you know, Western China is very auto centric. So the combination of all those things got a bunch of vacancy in Western China. It's about 70% of actually our total spec vacancy in the whole company.

But again, the impact on our P&L is going to be relatively small, given our interest, but we need to get it leased, and we are going through a strategy of actually going for occupancy and being less rent sensitive because green shoots in China are very short in duration, and we're going to get that back. And we've seen exactly the same movie in years past in other regions in China. So we're pretty confident that it will not be an issue long term.

The -- with respect to valuation differences, I can't think of a place in the world where valuation has not increased post-COVID. Maybe there are individual market-by-market differences. But in terms of U.S., Canada, Mexico, Brazil, China, Japan, Europe. Europe is probably the #1 decline in CapEx among all the global locations. And I think it has a direct correlation to 2 things. One, interest rates are at the start low, and everybody is pretty much concluded that they're going to be lower for longer. And secondly, the money that was otherwise being allocated to other sectors of real estate, like retail and hospitality and office is actually not going there.

So everybody has become a logistics aficionado. So a lot of that money. We're seeing people show up that we never saw before. So there are a lot more players looking to buy space. And I think that's a pretty good thing if you own 1 billion square feet of this stuff.

Our next question comes from Michael Carroll from RBC Capital Markets.

Can you provide some color on the tenants and or sectors that are currently being negatively impacted by the pandemic? Has Prologis already worked through a bulk of these issues? Or should we continue to expect higher churn, lower retention over the next, I don't know, how many quarters to several quarters?

I think our retention is going to be between 70% and 80%, like it has been forever, and there's always churn in the portfolio. And the normal cast of characters is probably concentrated in retailers and big box retailers that are being disintermediated by e-commerce. But there are some retailers that are doing extremely well. Obviously, the home improvement sector, as Mike mentioned, and the groceries and the like are doing pretty well. And a lot of the ones that are doing sort of well, but not super well are actually taking this opportunity to redo their networks and committing to new space because they now realize that e-commerce is not a theoretical threat to them, but they better get going on this because what they expected to see happen over 5 or 10 years has happened in the last 6 months.

So I think -- I'm not trying to duck your question, but you look at the list of the troubled retailers, the Penneys and the Sears in the world and all that and put it against out portfolio, we have 1 of 2 of them that, frankly, they're below my radar screen. I mean they're so de minimis, but our teams are very focused on them on re-leasing them. And there -- frankly, in many, many cases, those boxes are at least substantially below market. So we're happy to get them back and re-lease them. It's not an issue we would lose sleep over.

Our next question comes from Brent Dilts from UBS.

You've talked a lot about accelerating e-commerce and inventory builds. But could you speak in a bit more detail as to how those trends are developing in each of the global regions where you operate?

I'm not sure what you mean by detail. I think we were pretty early and adamant about this inventory rebuild. We went out and quantified it at 5% to 10%, and we gave you a projection on what that would mean in terms of incremental demand. And the evidence that's come in since that time is pointing more to the high end of that range as opposed to the low end of that range. That is a general trend. So it's expected more or less to affect our all markets evenly because generally, people are carrying more inventory.

The cost of carrying inventory is much lower because of the interest rates and the cost of missing the sales is very high. So people generally carry more inventory.

With respect to e-commerce, I think we've been pretty specific about the percentage of sales that are going to go through the e-commerce channel. And what the implications of that are on demand based on the 3x factor. So I think you can take those 2 facts and apply it to historical demand pictures in every market and come up with the math, but I don't think it would be proactive for me to try to go through 80 markets here and giving predictions that are not going to be correct anyway.

Our next question comes from Jon Petersen from Jefferies.

Hoping you guys can maybe talk a little bit about expectations around the election, specific -- maybe just high level, if you see -- if there's anything you're looking for that could impact your portfolio, but more specifically, California is a big market for you guys and Prop 15 would increase property taxes on commercial properties. So curious how we should kind of be thinking about impacts of that, if it does pass.

And then there's also been talk about Biden getting rid of 1031 exchanges. And just curious if you have any thoughts on what that would do to valuations and transaction volumes for the warehouse space?

Yes, it's Gene. I'll take the Prop 15 and probably kick the other question to Tom. So with respect to Prop 15, we -- first of all, we have to see if it passes. The polling looks right now like it probably won't pass. But if it does, there are a few things to keep in mind. One, it's going to take a couple of years for the individual county assesses to respond, mobilize and put it into action. The other thing is relative to Prologis, our average tax vintages is 2012. So we're in relatively better shape than, for example, local owners. And of course, this is passed through revenue to customers. And our real concern is taking care of our customers. And we hope this doesn't pass. It's just another tax in California to these businesses. But bottom line is long term, not a big impact to us.

Undeniably, there will be some effect on rent growth, but we have to see if this passes first. And on 1031s, Tom, will probably take that.

Yes, I'll take that. Clearly, 1031s are very embedded in real estate transactions. And that code, I think it's been around for almost 100 years. But I think that's the reason why we can clearly manage, if that change does happen, I don't know the probability of that change. But if it does happen, and we can manage it extremely well. The first thing is, from a sales perspective, we've always talked about, we can be extremely patient, we're very underlevered. We're quite frankly, underdeployed a bit, getting back to probably Jamie's initial question. And so we can be very, very patient on sales. And then the second thing would be our dividend payout ratio is in the low 60s, close to 60% this year, and we're generating about $1.1 billion of excess cash flow.

So what would happen if the 1031 exchange gets eliminated, right? Our taxable income could go up to the extent we sold assets and the capital gain component of our dividend would increase. And yes, that would put upward pressure on our dividend. But again, we've got significantly low payout ratio, and we're generating $1.1 billion free cash flow. So while we utilize it, we can certainly manage around it.

I think the bigger -- Jon, bigger issue than the 2 specific things you asked about is that California is becoming increasingly a difficult place to do business in. And it's not just these 2 things, but it's all the crazy propositions that are on the ballot this year. And if you really want to be entertained, you can read the ones that applies to San Francisco that are even funnier. But California better get its act together because otherwise, they're going to kill the golden goose.

And that is a concern for everybody. Having said that, it is the world's largest -- fifth largest economy and continues to be the set of innovation and a lot of other things around the world. So we muddle through on but sure, the politicians are making it very difficult for this economy to remain competitive. So that's much more concerning than Prop 13 or 1031 specifically at least to me.

Our next question comes from David Rodgers from Baird.

Tom, as we follow-up on maybe those earlier comments Hamid made about the K-shaped recovery and that lower leg of the K that everyone's trying to figure out.

Is there a way you could give us straight-line rent write-offs that you've seen in the third quarter and year-to-date to kind of provide some color on that? And then maybe just a follow-up. On the deferrals, I think you said 95% have been paid to date. Can you kind of give us a rundown just on the, I guess, level of direction of the deferrals. It seemed like maybe they were up a little bit in the third quarter versus second, but it may just be the way it's been quoted. So any color there would be helpful as well.

Sure, Dave. Thanks. So on your first one, just regarding straight-line rents. Those are netted against termination fees. So when you see our termination fees, those are net of those. I mean, listen, if termination fees are probably average $3 million a quarter, if you looked over a long period of time, I would bet -- I don't have the precise number, but I would bet the straight-line rent component $1 million netted against that.

So it's -- we -- it's calculated. We've certainly taken into consideration in our calculation bad debt as well. Regarding deferrals, I've been very happy with the deferral collection. So we've billed -- deferrals to date are about $40 million of deferrals at 61 basis points of annual gross rents, we billed 2 -- $20 million of that or half of it is due. We've collected 95% of that already. Most of that 5% to collect is really in October, but it's trending very normally with prior months.

So I would expect the vast majority of all that to come in. Of the $40 million of deferrals will dealt a total of 80% of that this year. So we'll knock that out of the way. We've got about half of it collected already, and we'll get another 30% by the time we get to at the end of the year. So I think this should be wrapped up by the time we get to the end of the year, we'll have some that will roll into '21, but it will get taken care of in good order. So I feel very good about collections and very good about the deferrals.

Our next question comes from Mike Mueller from JPMorgan.

If you look at upcoming development starts into 2021, are there any significant size or geographical biases to the pipeline?

Mike, this is...

Go ahead, Gene.

Sorry. Sorry, Chris. Let me start, Chris, you probably has something to add. It sounds like. There really isn't, Mike. And in fact, I think that's unique about the situation that we're in. Other than spaces under 100,000 square feet, which we generally don't develop much in that sector anyway. Demand has been and is becoming even more broad-based. So I really don't think there's any particular markets or product types, I'd call out. Obviously, there's been very significant strength in the big box sector, and we're going to meet that demand. But I don't think the composition of the deals looks much different than, for example, they did last year. Chris?

I would say in Europe, France and Poland are going to be low on that list in terms of places where I expect less than trend line development.

And I think Japan is going to be busier given the strength of those markets.

Our next question comes from Tom Catherwood from BTIG.

Tom, going back to your opening comments, you talked about rent growth and occupancy lagging in spaces under 100,000 square feet. And then, Gene, you just mentioned that, that has been a kind of broader-based demand center for certain tenants. But is the lagging occupancy and rent growth have to deal with the K-shaped recovery because these tend to be smaller tenants in these smaller spaces? Or is it that companies are finding they could accomplish e-commerce fulfillment out of larger facilities that are close to but not directly in population centers?

It's the former. And frankly, the smaller spaces have 2 kinds of tenants in them. They have big tenants in smaller spaces for their -- for the more closer in distribution and those are just doing fine. And then there are smaller spaces to lease the smaller businesses that are more vulnerable to this economic downturn. And therefore, there's more churn there. I expect that to -- and sort of the market getting better is because that a lot of that churn took place in the early days. And every day that goes by, the survivors are surviving and holding on. So I expect that to decline -- the problems in the small spaces and the small tenants to decline. And at some point, it will flip because in the aftermath of economic downturns, in the past, business formations have really skyrocketed. And I expect a lot of people that are either being laid off or losing their businesses will get back, dust themselves off and start new businesses.

So that will come back, but it may be a lag, but big businesses in small spaces are doing just fine, not a problem.

our next question comes from Craig Mailman from KeyBanc Capital Markets.

Maybe just going back to e-commerce and as it relates to maybe the U.S. specifically, but you guys threw out what Amazon was and what 3PLs were. I'm just kind of curious, as you run the data and see what you think expected demand incrementally would be from kind of that pull forward of e-commerce demand versus what you've already kind of put in the books or what the pipeline looks like. Do you have a sense of maybe describing as a wave, kind of when that wave kind of crest from a quarter perspective, and we kind of hit the peak of that demand and then it kind of trails off?

And how that is impacting potential development starts as you look out, not just for you guys, but for the market clearly, you guys are turning spec back on. I'm just kind of curious if others are turning spec on in anticipation of this and how that could potentially impact that rent growth as the expectation of the second half of '21 development deliveries would kind of really moderate if that may just not happen given kind of these other dynamics going on?

I think we're in the early stages of, certainly earlier than mid-stages of e-commerce growth. And I think what's happened in the last 7 months is that we've gotten 5 to 7 years of growth. So I don't think we're going to give any of that back. I think we are going to plateau for a while as people go back to regular shopping and restaurants and not eating at home and all those things, and then it will pick right back up at a more elevated level. So I -- the big wave you got to keep your eye on is the tsunami of e-commerce coming through. What happens to the ripples on top of that big wave frankly, in which quarter, I have no idea, honestly, and it varies market by market. But we don't run our business based on the ripples on top of the big wave.

In terms of are there dynamics in the marketplace that could make it difficult for the demands of that wave to be fulfilled? The answer is yes. The most desirable markets are the ones with the tightest land, the most difficulty in finding large pieces of flat land that you can build these buildings that e-commerce players demand, et cetera, et cetera. So with every passing day, we're having more demand from that sector. Now it's elevated and is stabilizing at a much higher level off of which it's going to continue to grow. And it's showing up a lot of the land that already was in short supply in the more desirable market. So I think that's the positive thing.

Our next question comes from Emmanuel Korchman from Citigroup.

It's Michael Bilerman here with Manny. Hamid, I want to come to sort of your view on the asset management business. Tom had made a comment in the opening remarks about your business, long-life, perpetual and comparing it relative to the listed asset managers in terms of how they are being valued versus how the business within Prologis is being valued. And I think you have shown tremendous amount of creativity in terms of structuring your enterprise, leveraging a lot of different structures, whether they're externally managed listed entities, using funds, incentivizing management with part of the compensation structure in that business. So I guess, are you thinking about taking it one step further and somehow making this entity either a public or a private entity to highlight that value? Or do you view this just as within Prologis, and we just hope the market would give you the appropriate value?

Excellent question. And let me -- just to pile on your question. Say, there are 2 businesses. One is the development business and one is the investment management business. That I guarantee you if I took the numbers of our development business, and it wasn't part of PLD. It was just a freestanding business. And by the way, we have those numbers going back to year 2000, okay? And showed it to your homebuilding analyst at Citi. I bet you he will value us at 2.5x book devoted to development business and a multiple that's more in the teens. And if I did the same thing with the investment management business, actually show them the numbers, the trends in those numbers the permanent capital nature of most of those funds, well over 90% and the stickiness of those and the promote will share those funds, I'm willing to bet you that they will put a 25 multiple on the pre-promote number and will give us the present value of the promotes on top of that.

And net of it is, I think both of those businesses are valued at about 30% to 40% of what they should be. Now that used to really get under my skin, and we spend a lot of time trying to figure out whether we can do a saucer section separation and all that kind of stuff. The governance issues that come along with that are very difficult and complicated and painful of where do you develop, how do you transfer them.

So -- and frankly, it doesn't matter anymore. It's a $140 billion enterprise and whether it's a couple of billion dollars here and there in terms of incremental value. Eventually, people will get it and will give us credit for it. So I guess to answer your question in a very straightforward way, it's a latter statement that you make. We've kind of given up. The complexities are not worth the incremental value that we may get in the short term. I'm sure we'll get it in the long term because the evidence is becoming -- it's sort of becoming so indisputable that it's kind of actually amusing at this point more than annoying.

Our next question comes from Jamie Feldman from Bank of America.

You had talked about upping your outlook for net absorption to 210 million square feet and completions to 290 million square feet.

Can you just talk more about what you're seeing from maybe non-REIT competitors in terms of their appetite to ramp up speculative development? And then also, we had this delay in construction, but what does this all look like heading into '21 and do you have an early read on what your supply/demand forecast look like there?

The answer to the second question is, yes, we have an idea what it will be, but we will share with you at the next call when we provide guidance for 2021. With respect to non-REIT players, they continue to be, by far, the biggest in aggregate sector of development, have always been, will continue to be the REITs as large as they may be, are, I don't know, 20% of the business may be in the more relevant market. So really, the private market is the vast majority of these activities. And I would say yes, there is some undisciplined development in the private area. But I would say other than Poland, I can't really think of a crazy example of that maybe Houston, Poland and Houston, but by a factor of 5, it's Poland and maybe somewhat in Houston.

And the reason for this is not that these private developers or public developers have forgotten how to build buildings or any less interest in build buildings. It's just really tough to find the land, the entitlement to build the buildings of the size that the market demands to meet a lot of this burgeoning demand from the big e-commerce users. So I think it's just tough. And so development levels are going to be muted because of a difficulties of navigating that.

I mean settlement time periods, for large pieces of land in the desirable markets, meaning the Northeast, the West Coast and all that are literally 3 to 4 years on large pieces of land. And you got to jump through all kinds of hoops and complexity. So it becomes difficult to tie up a piece of land to take it through the entitlement process. So you got to buy a lot here, buy a lot there, and it's just difficult. So that's what I would say about it.

Our next question comes from Caitlin Burrows from Goldman Sachs.

And Hamid, I think before you mentioned that there's a lot more people showing up as it relates to the transaction market and acquisitions. But for Prologis' 2020 guidance, it was increased, I think, now at $750 million at the midpoint from $600 million originally and lower than that last quarter.

So could you just talk about the current transaction market and how those 2 pieces line up of it seems Prologis is more confident on the your abilities, but then the commentary that there are a lot more players.

No, there are a lot more players and our acquisitions are not sort of the no-brainer acquisitions that are related to who accepts the lowest IRR just to say that they're in the industrial business. We're not in that business. I mean we show up at every one of those auctions because we want to keep people behind us will know what's going on. But honest to goodness, we're not buying a whole lot of clean, perfect, brochure cover qualities. I mean, if I told you about the market on some of those things, that we've seen recently, it's just beyond ridiculous.

I think most of our volume comes from more infill, more repositioning place, Last Touch place, urban place sort of stuff that the ratio of the cost of money to the level of effort and talent is skewed towards level of effort and talent and customer relationships. So we go where our strengths are. If it's a race to who accepts the lowest IRR, that's not the business we're in. We leave it to people who really like that business. And there seems to be more and more of them every day.

So -- but we have great visibility. As you know, you may remember that people always ask me about acquisition guidance. And I'd say $0 to $10 billion, and we've exceeded it on the top end in the past and we've been $0 at other times. We don't have a budget for acquisitions because it all depends on pricing and availability of quality properties. You can make your acquisition guidance Q1 of every year, but it would not be a prudent thing to do it. But when you get this close to the end of the year, you have visibility on really what's happening not only this year, but through the middle to third quarter next year, and that's what give us the confidence to increase those numbers. But they're mostly high effort, value-added types of things, not that passive, no-brainer deals.

Caitlin, I think that was the last comment.

So I want to thank everyone for attending our call, and we look forward to being with you in the new year and sharing our 2021 guidance. Thank you.

Ladies and gentlemen, this does indeed conclude today's conference call. Thank you again for participating. You may now disconnect.