Prologis Inc (PLD) 2006 Q1 法說會逐字稿

Good morning.

My name is Stephanie and I will be your conference facilitator today.

I would like to welcome everyone to the ProLogis first quarter 2006 financial results conference call.

Today's call is being recorded.

All lines are currently in a listen-only mode to prevent any background noise.

After the speaker's presentation, there will be a question-and-answer session. [OPERATOR INSTRUCTIONS].

At this time, I would like to turn the conference over to Ms. Melissa Marsden, senior Vice President of Investor Relations and Corporate Communications with ProLogis.

Please go ahead.

Thank you, Stephanie.

Good morning everyone.

Welcome to our first quarter 2006 conference call.

By now you should all have received an e-mail with a link to our supplemental.

But if not, the documents are available on our website at ProLogis.com under Investor Relations.

This morning we will first hear from Jeff Schwartz, CEO, to comment on overall market conditions and outlook;

Walt Rakowich, President and COO, will cover ProLogis' operating property performance and global leasing activity;

Ted Antenucci, President of Global Development, will discuss investment activities; and Dessa Bokides, CFO, will cover financial performance and guidance.

Before we get underway, I would like to state that this is conference call will contain forward-looking statements under 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).

I would also like to add that the first quarter results press release and supplementals 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.

And also, as we've done in the past to give a broader range of investors and analysts an opportunity to ask their questions, we ask you to please limit your questions to one at a time.

Jeff, would you please begin?

Thank you, Melissa.

Good morning, everyone.

We are pleased to be reporting another very strong quarter, with FFO growth per share of 43%, highlighted by continued improvement in operating property performance, expansion of our CDFS, relative to the value we created within our fund business.

We are pleased with the successful raise of our new $4 billion North American industrial fund and our ability to monetize some of the imbedded gains that are resident in our property fund business.

Our fund structures were design from the start to help us grow our global platform in a capital-efficient manner with the potential for significant upside.

And we believe we have additional opportunities to realize similar gains in the future.

During the quarter, we experienced strong customer demand and further strengthening in occupancies across our global markets, supporting record new development starts of more than $887 million during the quarter.

Leasing activity also remains strong, with our stabilized pool exceeding 95% leased, the first time in five years.

And our $4 billion pipe of CDFS completions, repositions, acquisitions and properties under development continue to be well-leased, at or ahead of pro-forma.

The explosive growth in global trade continues to support strong market fundamentals, which in turn, supports the acceleration in our global development pipeline.

We continue to see positive net absorption despite a pick-up in speculative development in many global markets.

Our ability to capture new development opportunities is closely tied to the talent and experience of our local teams around the globe.

Their in-depth market knowledge enabled us to closely monitor the balance of supply and demand.

In each of our markets, we watch absorption in key business indicators such as GDP growth, sales and inventory ratios, and manufacturing indeces very closely so we can be responsive to changing market conditions.

At the present time, key business drivers are all pointed in the right direction.

This is reflected in our same-store pool, where we achieved increases in net operating income and occupancies, while rent growth was modestly negative.

On this point, we believe the U.S. market is on the brink of realizing meaningful rent growth.

With occupancy levels approaching the mid-90% range in many key markets, increases in construction prices, and rapidly rising land values, rents simply must begin to grow in order to support the yields developers require.

On our last call, we mentioned our focus on sustainability.

Our global expertise in major redevolpment and mixed-use products and our ability to bring together best practices in environmentally-design and construction.

We made additional progress in this area during the quarter, with a groundbreaking river project at Dartford, outside of London, also known as The Bridge.

We were selected last August to lead development at this 264-acre brownfield site, which is the first of the U.K.'s major mixed-use regeneration projects and is located in the Thames gateway.

We have begun a 50 billion GBP -- 50 million GBP highway construction project there and have developed our first industrial facility, a 670,000 square foot warehouse, fully pre-leased to [Saintburys] who will use it to [inaudible] stores throughout London and the southeast markets.

Importantly, in many land-constrained markets in the world is becoming increasing difficult to be even considered for industrial development projects, unless you also have the capability and financial wherewithal to undertake redevelopment projects of this scale.

Our world class expertise in environmental technology and design also provide other sustainability opportunities to leverage innovative construction techniques all over the world.

A good example of this is our team in the Netherlands, which has taken the air-tight standards employed in the facility we developed for [Archer Daniels Midland] at the Port of Rotterdam, and implementing them in other new construction products in Northern Europe. [Archer Daniels] has estimated that this design feature is saving them 1.60 EUR per square meter per year in energy costs, which will obviously be a substantial savings over time.

Of course, our development -- our Catellus development subsidiary is the leader in redevelopment in mixed-use projects in the U.S. and we expect this part of our business will continue to expand.

Ted will have more on this in a few minutes.

In short, we feel great about the strength of market conditions and our leadership position within the world's largest logistics markets.

We will continue to focus on leveraging our strong customer relationships and unparalleled global platform to capture opportunities.

Which leads me to the most important point I want to make.

Our leading global platform of people, capabilities, facilities and customer relationships allow us a first look at customer requirements throughout the world.

And our size and leading position also makes us the developer of choice for municipalities, agencies and private land owners, from China to the UK to Austin, Texas.

Combined with our strong earnings and development pipeline, this allows us to be very selective and disciplined in choosing which transactions to pursue, whether they be developments, acquisitions or M&A opportunities.

We believe this discipline and the ability to pursue only the highest quality projects has and will prove a significant advantage.

Now, let me turn it over to Walt to discuss operations.

Thanks, Jeff.

First, overall demand remains very strong throughout our global markets.

Activity continued to accelerate in the quarter, as evidenced by our record leasing of more than 30 million square feet.

To put that into perspective, 30 million square feet is a 41% increase in leasing volume over the first quarter of 2005.

In addition, our occupancies remain above market averages in virtually every market in which we operate.

And overall occupancies on our stabilized portfolio stand at 95.2% at quarter end.

Let's look first at our international operations.

In Asia, first, where we are over 97% leased.

In both China and Japan, our projects continue to be fully leased by or shortly after completion.

For example, ProLogis Park Tokyo II, which is not scheduled for completion until late this year, is already 85% pre-leased to customers such as customers such as FedEx and Estee Lauder, with the remainder of the space fully committed by letters of intent.

In China we continue to make great progress in our parks in Shanghai and Guangzhou.

Of the 14 facilities recently completed in China, ten are fully leased and the remaining four are 75% leased or have very strong commitments from our customers.

We are especially excited about ProLogis' Park [Lingong] which is our exclusive park, we've talked about this many times, located just onshore from the new Yangshan deep-water port in Shanghai where we completed our first buildings this quarter.

In Europe, we are over 96% leased with continued strong activity.

First, the U.K., where customer demand and rents remain stable, despite a pick-up in inventory starts.

We had record leasing in the quarter of more than 1.6 million square feet.

And estimate that for all of 2005, our leading market share of leasing in buildings more than 100,000 square feet was nearly 22% throughout the entire country.

In southern Europe, we had good results despite a tepid economic outlook.

In France, we signed1.2 million square feet of new leases at our projects at Moissy-Cramayel, Cergy, Orlean and La Havre, well ahead of our plan.

Business conditions in Italy are uncertain due to the concerns of businesses following recent elections, but we remain well leased there.

And in Spain market conditions in both Madrid and Barcelona are stable with rents growing modestly.

Rent levels in the Netherlands are stable and we are beginning to see new requests for build-to-suit developments.

In Germany we continue to see cap rate compression and significant activity at our Munich Airport Park and at the Port of Hamburg.

In fact, we are in discussions with a major customer for a site in Hamburg due to our ability to support both ends of the distribution pipeline in Germany and China.

Activity in central Europe remains very good.

We signed roughly 300,000 square feet of new leases in Poland and our stabilized developments there are fully leased.

Due to the strong demand, we currently have nine facilities under construction in Poland.

In addition, we announced our entry into a fourth Central European market this quarter with our acquisition of 69 acres in Bucharest, Romania.

With this country's planned admission into the EU in 2007, we expect this to emerge as another strong market for us in Central Europe.

Now, looking at North America, markets continued to strengthen.

Our stabilized lease percentage in North America of about 95% at quarter-end was roughly 350 basis points above average occupancies in the top 30 U.S. markets.

Market occupancies in stronger areas like Los Angeles, Toronto and South Florida remain above 95%, while other markets like Atlanta, Chicago and Dallas, are now around 89%.

And while overall national occupancy levels remain flat compared with year-end, there continued to be positive net absorption of nearly 24 million square feet in the quarter, down a bit from last year's pace, though very -- still very strong.

For the year -- the full year, we expect absorption to continue to outpace deliveries of new space, helping to boost the national average occupancies by about another 50 to 100 basis points.

Now as Jeff mentioned, rental rates are beginning to rise in many U.S. markets, virtually closing any negative gap between our inplace rents and market rents.

In fact, during the quarter, we experienced positive rental growth in North America of 0.8% on 23 million square feet of leasing.

Today, in many cases, we are leasing developments at rents that are above our original pro-forma, underwritten just last year.

However, one of the most important ingredients to our long-term growth is driving repeat business with our global customers.

Nearly half our development completions continue to be leased to repeat customers.

In fact, our top 25 customers now have over 300 leases with us, an average of 12 leases a piece.

These relationships provide an important point of differentiation between us and our competitors.

Let me just end with an example. [Kune & Nagel], a European [three PL] just leased 150,000 square feet from us in Chicago.

Last year, we leased space to this global customer in Poland and Germany, and we now serve them in nine markets across North America and Europe.

We are also in discussions with them in Asia for two facilities and are confident that they soon will represent our sixth customer on three continents.

This shows the power of our global network and these are the very relationships that will continue to fuel our growth ahead.

Now, let me turn it over to Ted who will discuss investment and disposition highlights.

Thanks, Walt.

The help of the global demand that Walt just described, supported total starts of $887 million, by far a record quarter.

This activity brings us to a record CDFS pipeline including completed facilities, repositioned acquisitions and properties under development of more than $4 billion, all of which are 49% leased, on average, as of the end of the quarter.

Beginning in North America.

Starts included build-to-suits in Reynosa and Tampa, with inventory projects initiated in Los Angeles, Dallas, Charlotte and Las Vegas.

In Europe, we had a record level of quarterly starts with roughly $328 million of new development, including build-to-suit facilities in Stockholm, La Havre, Northern Germany and London.

Inventory development was strong in several markets in Poland, France, the Czech Republic and the UK.

In Asia, we began more than $437 million of starts.

Repeat customers drove a significant amount of new development in Japan, where we began a pre-leased facility for Hitachi outside of Osaka and another pre-leased facility to a major repeat customer in Sendai.

We also started multi-customer inventory projects in Tokyo, Osaka and Nagoya during the quarter, totaling more than 3.75 million square feet.

In China, we began development of a new facility of ProLogis Park [Yung Fu] outside Guangzhou.

I would also like to update you on our progress at some of our major mixed-use and redevelopment projects.

At our Pacific Commons project in Fremont we have broken ground on our third phase of retail development, representing over 200,000 square feet, with total expected investment of $59 million, which is already 42% pre-leased to major retail customers such as Staples and Jo-Ann Fabrics.

In an LA Air Force base, we have completed the development of the office buildings.

The Air Force has moved into those facilities, and in early April, transferred the land to us in exchange for the office buildings.

We are beginning the process of improving the land and have reached an agreement to sell it to a residential builder.

We expect this transaction to close later this year.

Now for an update on the sales of the Catellus non-core properties.

During the quarter, we completed the sale of the Santa Fe office building in Chicago, bringing us to a total of $362 million of completed dispositions.

In addition, we have office properties in Colorado and California, as well as the San Diego Embassy Suites Hotel, under contract for an additional $185 million, and are negotiating agreements for another $132 million of sales, for a total of $679 million of dispositions completed, under contract and under negotiations.

We expect to close on these pending transactions by the fourth quarter, thereby completing the bulk of the $750 million of planned dispositions we outlined last September, well ahead of our initial expectations.

Importantly, the average sales count rate for these assets is approximately 6.68%.

And we have either closed or under contract on 1031 exchanges, with an average cash deal of roughly 6.42%.

When we first underwrote the Catellus merger, we projected a drag of 100 basis points between disposition and acquisition yields as we transitioned into core properties.

The actual difference is only 26 basis points, which is substantially better than we expected.

This is primarily due to better than projected values on the office and hotel sales, along with industrial acquisitions producing better than pro-forma lease up. 89% of the acquisitions are in our largest markets;

Los Angeles, New Jersey, Atlanta and Chicago.

In short, our 1031 program is almost complete with better than expected results.

And now, I will turn it over to Dessa.

Thanks, Ted.

As noted earlier, we are on-track with our major business drivers for 2006.

Our FFO per share was $0.90, before $0.01 of merger integration and relocation charges, up 43% over the $0.63 we achieved over a year ago, prior to $0.08 per share of relocation expense and temperature-controlled charges.

Our gains relate to the new North American Industrial Fund were $0.015 less than forecast, due to expenses within the funds being higher than originally anticipated.

This was more than offset by strength in our property operations and CDFS business.

All three segments of our business performed well in the first quarter.

Property operations were strong, with occupancies close to historic highs, at 95.2% for the quarter.

In our same-store pool, we experienced NOI growth of 3.7% and occupancy gains of roughly 4% that were offset, as expected, by slightly negative rent growth of minus 1.1%.

While cap rates have stabilized in North America, we are beginning to see evidence of increased lease rates.

Lease rates, however in Europe, are still decreasing as long-term leases roll.

As a testament to our excellent customer relations, our customer retention rate was at 73%, high -- was at 73%, higher than our expectation of 68 to 70% for the full year.

Turning now to development activities relative to expectations.

First quarter starts of $887 million, including retail starts of $59 million, are tracking well ahead of our full year expectation of roughly $2.3 billion.

Our starts were more heavily weighted towards Europe and Asia than North America in the quarter, although we still expect to have healthy starts in North America during the year.

CDFS dispositions are tracking under our expected pace of $2.2 to $2.4 billion for the full year, at $364 million.

As we have noted previously, however, CDFS dispositions will be lumpy on a quarter-to-quarter basis.

After adjusting for the $13 million of previously deferred gain related to the North American Fund transaction, CDFS, post-tax, post of real margins were 14.3%, just slightly above our mid-tens expectations.

Fees from funds of $38.6 million were in line with our guidance of $95 to $100 million for the year, including the $22 million promote for our funds transaction.

Likewise, our share of FFO from property funds at $53.9 million was on track with full-year fund FFO guidance of $135 to $145 million, including the $27.9 million from the fund transaction.

Overall, we recognized approximately $63 million of deferred gains, incentive fees and property fund gains from the new North American Fund transaction.

This was down slightly from our projection of $67 million, due to a decrease in our share of fund gains, to $27.9 million from $31 million.

The restructuring of these portfolios is an excellent example of how we can manage asset in a fund that is set to expire or investors objectives have changed and contribute those assets into a new or existing fund.

Thereby, both creating and unlocking value while perpetuating the income that we will recognize on those assets in the future.

Our expectations for other income from development management, JVs and other income continues to be $55 to $85 million.

The components of this section appear on three separate lines on the FFO statement.

First, $4.2 million is in development -- on this year's quarter is in development management and other income.

Second, $4.7 million is in FFO from CDFS joint ventures and other consolidated investees.

And third, $5 million is in interest income on long-term notes receivable.

For the first quarter, the total of these line items was $13.9 million.

Remember, the revenue in this area will also be lumpy, as some of it will be related to infrastructure and development fees, for which is difficult to predict timing.

On the expense side, interest and preferred dividends of $77.8 million were basically inline with our guidance.

G&A of $33.8 million, on an analyzed basis, will be slightly higher than the 10 to 20% increase we outlined.

However, it is not unusual for G&A to be more heavily weighted to the first quarter due to compensation-related expenses.

In addition, due to the reclassification of the income and expenses for our deferred comp program, we expect reported G&A to be approximately $5 million higher than forecast for the year, offset by corresponding increase in interest income.

From an adjusted FFO perspective, total capital expenditures of $25 million, including our share of property fund CapEx, were on track with annual guidance of $100 to $115 million.

From a balance sheet perspective, we completed an $850 million bond offering and repaid bridge financing associated with the Catellus merger, keeping our key ratios in line with prior conservative levels.

Our total debt-to-book capital remained relatively constant at 54%.

And our interest coverage ratio was strong at 4.3 times.

Thank you.

We are looking forward to providing you with additional detail regarding our performance and opportunities on our next call.

Operator, we are ready to take questions.

Thank you. [OPERATOR INSTRUCTIONS].

We'll take our first question from Ross Nussbaum of Bank of America.

Hi, good morning.

Jeff, I may have missed this, did you provide your updated FFO guidance?

We are -- at this point, we aren't changing our guidance.

We are very comfortable with the range that we are in.

And believe that it is a very comfortable range for us.

We will continue to look at it throughout the year and we will re-examine it in future quarters.

Ross, we don't believe you miss anything.

Our next question comes from Paul Morgan at FBR.

Good morning.

Jeff, I think it was you who mentioned a pick-up in speculative starts in a number of markets.

And I was wondering if there are any markets, globally, that you would highlight as ones where there's -- it's giving you pause that the pace of spec development may be ahead of fundamental demand?

Markets where you are not seeing positive net absorption, where you are seeing potential for overbuilding.

Let me pass that question on to Ted or Walt.

Ted's been spending a lot of time traveling around the world the last few weeks, as well as Walt.

Either one of you guys?

I will start off and then Ted can give you some anecdotal comments about markets.

Paul, let me -- I would say from an aggregate perspective, if you look at the numbers and we track the top 30 markets at least, last year we saw net absorption of 177 million square feet.

We went into the year thinking we would be at 150, so we were significantly higher.

And we saw new starts of about 115 million square feet.

So needless to say -- and actually new deliveries, probably a more relevant number, of 105 million square feet.

This just in the U.S.

So you can see we had just below-out net absorption numbers last year relative to completions.

We think the starts are going to rise to probably closer to 130 million-type square feet, maybe even a little bit more than that this year.

And we also think net absorption might fall a little bit, instead of 177 being in the 150-ish type range.

So they are still converging, but still not out of line.

And that's why we think that national occupancies will still rise by roughly 50 to 100 basis points.

So there aren't any markets that really, really concern us.

There are a few that probably are slightly more out of whack than others.

And maybe, Ted, you can comment on a few, if you like.

But I think, in general, the markets in the U.S. are in very good shape.

And I would say globally, there's not a market -- we have seen a pick-up of starts in the U.K. but we are still leasing buildings just as fast as we can build them there.

So there's nothing alarming in the UK at all.

No structural vacancies.

No -- structural vacancies probably less than 5% today.

Ted, I don't know if you want to comment on any markets.

You covered it -- kind of overall.

There are definitely pockets of, in the U.S. in particular, where there is a lot of development going on.

And in some pockets, more than we would like to see.

But for the most part, overall occupancy levels are doing really well.

And demand is strong.

And we are seeing real rent growth in the majority of the markets.

And overall, I think -- right now, things are doing really well throughout the U.S.

I would answer it in a different way, too, Paul, to say there's no market in the U.S. today that we have completely red-lined and we are concerned that we wouldn't build a building if we had the right piece of land or the right customer relationship.

Our next question comes from David Harris of Lehman Brothers.

Good morning, everybody.

I don't know if you looked in any detail at the proposals to in introduce a [weak-like] structure in the UK.

I just wanted to know if there might be some optionality with regard to planning for the -- around the European fund.

It's Jeff and I will answer that.

I have looked at the proposed regulations and what the Treasury looks at introducing in the U.K., that was introduced about 30 days ago.

We think it's a good structure.

It does give us increased optionality.

Whether it's the best structure for a pan-European entity or not remains to be seen.

We continue to explore all options in Europe and elsewhere to create the most shareholder value with as much structure as we have today.

Our next question comes from Jonathan Litt of Citigroup.

Hi.

I wanted to come back to the guidance question.

With the pace of starts running greater than we had expected, it would seem as though your deliveries this year may exceed the $2.2 to $2.4 billion -- or the dispositions that CDFS funds.

And I guess I was looking for some color on that.

I think also these margins that your generated in the quarter, were probably a little biased by Europe being a big piece of your contributions.

I was wondering if you could give us some color on the margins by region?

Jonathan, maybe I will start and turn it over to everyone else.

But we still feel very comfortable with our guidance on development starts for the year.

We had a very strong first quarter.

One quarter does not make a year, but obviously, we are excited about results for the first quarter, both development starts, operations, clearly -- overall business we are very, very excited about.

We did have a lot of contributions from Europe which have performed very well in the quarter.

Walt, do you want to add anything -- any color?

We had good contributions from Europe.

We also had contributions in North America and in -- from Japan -- we had a couple of contribution, also.

I think across the board the kind of -- the 18% was a pretty good number across the board for our margins.

The -- I think that, as far as whether contributions will accelerate or not, I mean we are still looking at the market.

It's early in the year and we will continue to update you if we see that that's changing over the year.

Jonathan, the only comment I would add to that is we had $877 million in starts in the first quarter.

I don't think that you should take that times four and assume that we will be that kind of number,r in terms of starts for the year.

Because it is -- it's clearly driven by -- if you look at it, there's over $400 million starts in Japan and I don't think in Japan will do $1.3, $1.4 billion of starts this year.

So it's going to be lumpy.

It's going to kind of -- we think it's going to trade, at this point in time, it's going to be within the range that we outlined.

If it's more than that, I think that's good news for everybody on this call and our shareholders.

And that would be very, very exciting.

And if we could keep the margins at 18%, as well, that would be even more exciting.

So one quarter doesn't make a year.

But let's just put it this way, moving into the year right now we feel very, very good about what we see.

Jonathan, it sounds like you have a little bit of a cold.

I hope you feel better.

Our next question comes from Lou Taylor of Deutsche Bank.

Yes, hi.

Just along the same lines, Walt, maybe talk a little bit about the mix of starts over the balance of the year?

How they fall geographically?

And along the same lines of the margin questions about -- can you give us a sense of cap rate changes directionally in the various continents?

Yes, I can.

Let me give you -- let me speak first of all to the starts.

Because the number that we kind of outlined was 10% in excess of last year's starts, which would put us in -- roughly the $2.2, $2.4 billion range.

And the way that that breaks down is that -- I would say that Europe -- and I don't have the numbers in front of me but roughly, the U.S. would be probably $700 millionish, maybe as high as $800ish million in starts.

Europe would be somewhere in the neighborhood of $800 to $900.

And Asia would be the balance of that.

And so -- and that mix may change plus or minus $100 million, depending on the continent.

So if you look at the numbers, we started off with starts in the U.S. at only a little bit over $100 million.

So I think we feel pretty confident to say that in quarter two, three and four, you will see that starts in the -- in North America will probably pick up relative to other continents.

Europe at $300 is probably a little bit high on a run rate basis to what we thought.

So I think will you probably see slight decrease in Europe, on a relative basis.

And then Asia at $437 million will not be at that run rate.

You may see that times two for the whole year.

So I think in -- on a disproportionate basis, North America will pick up relative to Europe and Asia.

And that is simply -- really just a function of -- well, a couple of things.

One, you don't tend to start a lot of buildings in North America in January, February and March.

Historically ,we haven't.

We have more in Asia.

And the other thing is -- it'sjust subject to leasing and buying land and making sure that you have entitlements in the place you want to do.

And also build-to-suits, sometimes build-to-suits are higher in certain regions than others.

I think, overall, we feel very good about the number.

Probably more of a pick-up in the U.S. relative to other areas.

On cap rate changes, we feel that cap rates, generally speaking, in the U.S. are flattening out.

Although I made the comment that I think in some secondary -- or U.S. markets that we might continue to see some compression, at least that's what we've seen.

And I think that that really bodes well for rental growth.

Because you don't see developers doing lower and lower cap rate deals and driving down rents.

We feel in Europe, you -- probably cap rate compression is not complete.

We continue to see cap rate compression on the continent.

We see it still, somewhat, in the U.K.

And so I think we are going to continue to see some rent declines as a result of that in Europe.

And then finally in Asia, I would say, Jeff, you may want to comment on this, or Ted -- I think, overall, cap rates have either been stable or still coming down.

Absolutely.

We've seen [scooping] cap rate compression in Japan.

Quite frankly, more inline with where they should be, but on a relative basis, higher than elsewhere in the world.

If you look at the margin above treasuries, they have the best spread in Japan of anywhere still.

Although we have seen probably 150, 175 basis points, maybe closer to 200 basis points compression cap rates over the last three years in Japan.

And in China, it's nothing short of phenomenal, because everyone truly expects, and is really achieving, 5 to 10% annual rental growth on properties and the cap rates reflect that -- the expectation of real growth in cash flow over the coming 10, 15 years.

Our next question comes from Chris Haley of Wachovia Securities.

Good morning.

Walt, I have a question for you regarding capital capacity.

The reason for -- one of the reasons for the Catellus transaction was to expand the capacity to fund a growing development and investment pipeline, in addition to accessing land and management, et cetera.

I would be interested to get your color on what you believe your capital capacity is today?

And how we can monitor it, based upon your supplemental report, in light of a growing development commitment?

Well, I'm going to probably turn the capital capacity issue over Dessa, but let me just make a general comment -- that it's really, Chris, been --

Chris, Walt's an operating guy now.

Just want to do is comment from last year.

[laughter] -- all those files off to Dessa, that's not my question.

But I will say this, it's been pretty obvious that we've taken our development pipeline over the last couple of years from -- what was it, $2 billion pipeline to a $4.

Needless to say, with the Catellus merger we felt we had adequate capacity to do that and we could see that coming.

And it has been our intention, quite frankly, to build that pipeline.

I think that that is also a good thing for our shareholders.

And it's a good thing for everyone on this call.

And I think it will provide great visibility to earnings in the next couple of years.

So this has been an intentional thing that we have done.

But having said that, let me turn it over to Dessa on the capital capacity.

As far as the capacity goes, there are a few ways in which we are funding the business.

One of them is through the recycling of capital in the funds.

We have established two large funds in the last six months, realistically, $4 billion dollar North American fund and a $3 billion Japan fund, too.

Both of those will give us the ability to recycle capital as we contribute assets, going forward.

The other areas we have increased a little bit are debt capacity -- debt outstandinging to fund some of the new development.

We are seeing such good demand out there and excellent opportunities, from a development perspective, that we believe that we should be building a solid pipeline.

And that as far as tracking the capacity, it really is our ability to keep the properties leased and continue to contribute them on an ongoing basis.

That's really where we will get that capacity.

And I think that you can track it basically by looking at those line items.

Where the development starts are, how well they are leased and our take-out commitments in the funds, as well as our debt capacity.

Chris, I would -- and I would echo what Dessa is saying.

I think at some point in time, the capital recycling will substantionally increase, it already is now, we've talked about $1.7 billion last year we did $1.3 billion.

The capital recycling has to follow the increase in starts.

Needless to say.

And you will see that occurring in the next 12 to 18 months.

Another way of looking at it is looking at the total capacity within our funds as additional capacity to grow the company.

So when Dessa talked about the new $4 billion North American fund that our team worked so hard on -- the entire team worked so hard on in the U.S.

That's capacity to grow the business.

The $3 billion Japan fund that Masato Miki and the fund management team in Japan worked so hard to put together -- that's capacity.

So that's capacity without getting into any sort of debt constraints.

Our ability to grow the business remains very, very strong.

And we just continuing to grow the operations, grow the talented group of people that we have around the world and execute with our customers.

Our next question comes from Mike Mueller of JP Morgan.

Hi.

With the open end fund, now, up and running for about a quarter or so, have you had any requests or indications from investors in your legacy funds that they want to be moved into that vehicle?

Mike, that's a great question.

And, no, we have not, although I will say that the fund has only been operating now for a couple of months.

I think it's a great question, quite frankly, and it's one that would be a discussion that we would have with our investors down the road if there was an interest on their part.

But up to now, the answer to that is -- we have not pushed or entertained any of those discussions.

Many investors in other funds also went into this fund with new capital --

Correct.

That's very true.

-- so to be changing out in just a couple of months timeframe doesn't make sense.

It gives us -- getting back to some of -- where someone used it a little bit ago, it gives us -- this was David Harris -- it gives us increased optionality.

Our next question comes from Matt Ostrower of Morgan Stanley.

Morning.

Going to the $28 million gain that you guys booked on the -- effectively on the creation of the North American Industrial fund, transferring the assets from the old North America II through IV -- I guess one question is that -- I guess it was our understanding that you guys thought that it was -- that gain would actually not be technically part of NAREIT FFO.

And it looks -- in your disclosure on the supplemental you were calling that part of NAREIT FFO and not part of your adjustments.

And then also, could you sort of walk through for us the basis in each one of those transactions -- or each one of the gains that you recognized along the way, starting with the liquidation of II through IV?

And then how do you get to $28 million?

Well, first of all, the description of it is -- our description of FFO is how we define it.

And we define it very carefully in our supplement.

So we do have it in the -- it is not in the NAREIT definition but it is in our definition of FFO.

As far as the individual components, we are not going through every one of the funds.

But overall, it was a $28 million gain on the basis increase.

And what I can -- we can walk you through on another -- on an individual call, the different components and where you find those in our supplemental.

Dessa will give you a call.

We don't want to go through everyone's time to go through detailed numbers, ad nauseum.

But clearly -- it's a good question.

We will call you back on that.

David Fick from Stifel Nicolaus.

Just a follow-up on that.

In gross, how much of the asset capacity in the $4 billion North America fund is being met by rollovers of prior funds?

David, the contribution is roughly -- a little bit less than $800 million.

And the capacity -- $763 million to be exact, which was put in front of me.

And we think the total capacity in the fund, David, with reasonable leverage at about 55% would be about $4 billion.

So the fund is kind of about 20% committed.

And then will you see development contributions coming in quarter two, three and four for that fund.

And that will take it well over $1 billion for the year.

So basically, we took out three funds; fund II, III and IV with this particular fund, it's now 20% or 20 some-odd percent committed.

The important thing to note is, we clearly closed down subscriptions, we scaled back some people that would have preferred to invest more.

And it was so over-subscribed, we could have raised a multiple of what have we raised.

So to the extent -- there are opportunities exceeding the amount we raised today, we do have the ability to go back and raise more capital in this fund.

But we are very, very comfortable with the amount we raised.

Want to make sure we perform well and we exceed the expectation of the investors we put into the fund.

Keep in mind that it is an open end fund, back to Jeff's point, so we do have the ability to continue to do future capital raises within that same fund and continue to grow it.

We have a follow-up question from Ross Nussbaum.

The question is regarding your margins.

Assuming that you are going to have more properties coming on line from Asia later in the year, is it fair to assume that there is a -- potentially an upward bias to the margins, as opposed to a downside bias?

Ross, I read about some of the things that are written out in the marketplace.

I don't think on any call that we've ever made that we've said that our margins in Japan or in Asia, for that matter, are better than our margins elsewhere on a long-term basis.

I think we feel that they are pretty much the same throughout the world, plus or minus 1 or 2%.

So I wouldn't -- I wouldn't draw that conclusion, necessarily.

We -- I think what we said going into the year is that we really believe that you are going to see lessening cap rate compression, and as a result of that, we believe that our margins would go from what was an extraordinary number that started with a 2 last year and into kind of a mid teens type number.

We are beginning to see that happen.

When we do 18% after deferral this quarter.

We -- that's a strong number, relative to the total year expectations over.

Overall, we still feel good about the guidance we gave earlier year.

Ross, we -- obviously last year we had some very significant margins coming out of Asia.

It was flawless execution by our team in Japan.

Leased up well faster than -- way, way ahead of pro-forma, lease rates ahead of pro-forma.

And that combined -- good control of budget.

Nothing came in above budget.

Everything was, on average, below budget; as well as -- it's a good thing cap rate compression.

So it was absolutely perfect execution on their part.

What I felt would be interesting, Ted spent a good deal of time in Japan, spent a lot of time with our development team there.

And he had some impressions he wanted to share.

Hi, Ross, I just got back a -- Jeff and I, a couple of weeks ago.

And I had met our team from Japan in the U.S. after the merger, and I know we have an investor tour coming up and I'm not sure if you are going on it or not, but it's amazing what's going on in Japan and the team that we have out there.

I was blown away by the projects that have been completed and what's under construction.

And the mix of build-to-suits versus inventory product is really impressive.

They are -- I think I will use the turn Walt uses -- they are clicking on all cylinders.

And it's -- it's been a great opportunity for ProLogis to grow to the biggest market share in Japan.

And I think that we are all really proud of what's been accomplished out there.

And you have seen it in our operating results.

We have a follow-up question from David Harris.

Hi, this is to you, Jeff, you speak with so much enthusiasm about Dartford, I wonder if I could just press you -- is there any public subsidies involved on that project?

And I'm also wondering how close you are to some of the proposed Olympic sites?

How you might be a beneficiary of some infrastructure improvements that might come in over the next couple of years?

Very good two-part question.

It's -- when you say public subsidies, we did not receive any money, either from the government nor from the local government directly to subsidize the project.

However it is a joint venture with the local municipalities.

When I made the comment before about being the developer of choice, the team that we have in the U.K. is very, very, very strong.

They are good on execution.

As Walt said, they have 22% -- of leading market share, 22% of all leases done in the U.K. last year.

The developer of the year the last several years in a row.

Great, great quality group.

Also have focus on sustainability issues, being environmentally conscious, as you know, in the U.K. and now in the EU -- the commission is enacting certain standards that buildings have to conform with.

U.K. is doing the same thing.

And we are the leader in this area.

All those thing made us very attractive to Dartford, as well as our local platform of customer relationships to be the developer.

And it is a joint venture with a municipality where they contribute the land, we put all the infrastructure dollars and there's a sharing -- it's well-structured, it's a very safe, sound investment for both parties, with significant upsides for both parties.

So in that sense, it is a joint venture with the local municipality.

And we were selected amongst many, many developers that wanted to develop this site.

As you do know, it is very close to Olympics -- to most of the Olympic venues.

And there is a tremendous amount of infrastructure that will go in between now and 2012 of which we will be -- indirectly, the beneficiary of that.

Staying on the Olympic theme, we are doing a lot of development related to the Beijing Olympics in 2008, which is a little closer than the 2012.

The 2012 will help us very directly with the major development in London and with there's some announcements that you'll see forthcoming relatively shortly about our involvement and about how things are going on with the Olympics are helping our business in China.

We have a follow-up question from Jonathan Litt.

Hi.

Just wanted to follow-up on the margins, I think that maybe it has not been quantified precisely.

Clearly, Asia has been achieving historically better margins than the rest of the world, in part because of the cap rate compression taking place in that region.

And Jeff, from your comments, it sounds like that is continuing to happen.

I guess one of the things is land tends to -- if you own your land for a long time, the ability to continue to achieve those excess margins is more likely.

As I look at your land inventory in Asia, it looks fairly low, at about 50 acres direct-owned, 261 controlled.

Can you talk about what's happening to land prices there?

And assuming that Asia is going to achieve better margins, I guess we would assume, if you are staying with the mid-teens margin, then U.S. and Europe are probably going to have sub-par margins?

I'm not certain that U.S. and Europe will have sub-par margins.

We continue to believe that's a -- we are in a 14 to 18% margin type business in our development.

We cannot plan for continued cap rate compression.

That would be -- to me, that's a risky way to look at the world and a risky way to go about running the business.

If it happens, it's fortuitous and we are the beneficiary, as well as our shareholders, of it happening.

Do I think there's a possibility of some continued compression in Asia?

Absolutely.

But we do not plan or project for it.

In Japan, as you know Jonathan, you've spent some -- you were one of the first people to go over there and spend some time with me almost three years ago-- maybe a little bit more than three years ago, time flies by.

It's very, very, very expensive to land bank or warehouse land, given the prices for good sites.

And also with the demand we have, as soon as we can acquire a good site we are typically starting a development.

We do have some land bank there.

We bought some sites where we built two to three buildings, started the first building and have the second and third sites available.

Although, even those we've go through relatively rapidly and not looking at a four to five year hold.

It's just in the last year that you've started to see some appreciation -- good sites in Tokyo and around Japan.

Prior to that, as you know, from the burst of the bubble in 1990, we saw significant decline in land values that ran through 2004.

Really around 2004 land stabilized, 2005 it started to uptick a little bit.

But we are looking at -- projections are 2 to 3% appreciation in land prices -- it's not a wild appreciation of land prices in Japan -- already at significant levels but clearly, stable and appreciating.

We are building some land bank.

But it's very, very expensive to do so, quite frankly.

Our leasing velocity and our demand is so high, which is a good problem -- it's not a problem at all, it's a good situation that we are building buildings as we parlay them.

And have a team of people that do nothing expect source land.

We have really good people doing that.

That's a full-time job for them -- sourcing land, working with banks, working with companies, working with private land owners to acquire sites.

In China, our team there has done a, quite frankly, a masterful job of optioning land, which is a far better way to land bank if you can do that.

If you look at our project at [Lingong] Port, we have rolling options.

Phase one is 15 million square feet.

And we only took down the land for the first million square feet, which we are building.

And then we have rolling options.

And then after -- the way our agreement works, after we build out that 15 million square feet, we roll into another option for a similar size plot of land.

And again, rolling options within that area.

We've done the same thing in most major cities around China.

It's been very, very strong execution by our China team.

And we've been able to negotiate land options at fixed price or with very marginal annual increases, which from a shareholder value standpoint and a dilution standpoint, is a far better way to run the business.

And they've been successful in doing that in China.

In China, you are seeing significant land appreciation.

Order of magnitude in Shanghai, land prices went up north of 20% last year for industrial land.

So by locking in option prices at fixed costs -- fixed prices, we made a lot of money in that sense.

And that will translate to value in the future.

Our final question will come from David Fick.

Yes, you had a conversation, Dessa, led on your capital raising and recycling.

I didn't hear any commentary in there about your shelf registration or any intent you have might have with respect to equity offering?

I know you are hesitant to do that.

But I'm just wondering if you might comment on what circumstances might cause you to do so?

Our shelf registration was a universal shelf registration, so we did put all different types of securities in it.

It was not because we had an intent to do an equity offering.

And at this point, we believe the capital recycling program and the -- our debt capacity gives us capacity out for a number of years -- at least a few years of capacity to continue to grow at this pace.

And with the capital recycling into our funds, we are very comfortable that we can continue to develop it at a very good clip, going forward.

That shelf registration, the fact that it had equity in it was not because of an intent, it was just because we made it a universal shelf.

And at this time, we have no further questions in the queue.

Would like to turn the call back over to Mr. Jeff Schwartz for any closing remarks or additional comments.

Thank you, Operator.

And thank you, everyone, for spending time with us this morning.

Obviously, we are very, very excited about the first quarter.

Very excited at our prospects for this year and looking forward into 2007 and 2008.

We are excited about the platform, the people we have around the world, the customer relationships, development projects and the overall state of our operations.

As Ted spoke, he and Dessa spent a significant amount of time in Asia the last couple of weeks, where they got to know the people there.

Walt was traveling significantly in the last, well, the 12 years, but particularly the last month or so.

And he has spent a lot of time with our teams around the world.

And we are all feeling very good about the businesses we are building.

And we look forward to seeing a lot of you at NAREIT in -- about a month, month and a half.

Thanks.

Ladies and gentlemen, that does conclude our presentation for the day.

We do appreciate your participation.

At this time you may disconnect.