Prologis Inc (PLD) 2006 Q3 法說會逐字稿

Good day, everyone.

My name is Abe and I'll be your conference facilitator today.

I'd like to welcome everyone to the ProLogis 2006 financial results conference call. [OPERATOR INSTRUCTIONS]

At this time, I'd like to turn the conference over to Ms. Melissa Marsden, Senior Vice President of investor relations and corporate communications with ProLogis.

Please go ahead, mam.

Thank you, Abe.

Good morning, everyone.

Welcome to our third quarter 2006 conference call.

By now, you should have all received an e-mail with a link to our supplemental package, but if not, the documents are available on our website at ProLogis.com under investor relations.

This morning we'll first here from Jeff Schwartz, CEO, to comment on overall market conditions and outlooks.

Walt Rakowich, President and COO, will cover Prologis' operating property performance and global leasing activity, Ted Antenucci, President of Global Development, will discuss investment activity.

And Dessa Bokides, CFO, will cover financial performance and guidance.

Before we get underway, 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 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'd also like to add that the third quarter press release and supplementals do contain measures, such as FFO and EBITDA, that are non-GAAP measures.

In accordance with Reg G, we have provided reconciliation to those measures.

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

Please begin, Jeff.

Thank you, Melissa, and good morning, everyone.

We're pleased to report strong results for the third quarter, bringing us to 20% increase in year-to-date FFO per share over the last year.

Overall, we continue to see good momentum in the business.

As we move into the final months of 2006, we are extremely well situated, with unequalled land positions, a solid pipeline of properties under development, and strong leasing on our recently-developed facilities, all of which we expect will support CDFS gains and expansion of our property fund business into 2007 and beyond.

Our big news for the quarter was the successful IPO that ProLogis European Properties, or PEPR, which is now trading on Euronext Amsterdam.

Our team did an exceptional job of execution.

While several anticipated European property company offerings didn't make it to the market, institutional investors were very receptive to our offering.

In fact, it was the largest ever real estate IPO on the continent.

It also represents the best opportunity for public equity investors to invest in a Pan European portfolio of industrial properties.

The IPO proceeds totaled more than $9 million, including the green shoe, bringing PEPR's market cap to more than $6 billion.

Due to the strong returns generated by the fund to its investors over the past seven years, we will recognize $109 million incentive return in the fourth quarter.

Dessa will have more detail on these gains shortly.

This transaction's meaningful for several reasons.

Not only did we crystallize the value to promote, but importantly, we provided liquidity to our investors through an infinite life vehicle and a secure long-term management agreement with ProLogis.

We will have the ability, after year two, to earn an incentive return each year based upon the funds returned relative to NAB.

And as we stated, since becoming the public sector's innovator in the property fund business in 1999, we have a variety of liquidity options with our funds.

With the PEPR IPO and our liquidation earlier this year of North Amerians fund two, three and four, we've demonstrated our ability to capture value for our all of investors, perpetuate our management theme -- our management fee stream, and shift assets under management into infinite life structures, while creating the opportunity to recognize incentive returns on a more regular basis.

As a result of the PEPR incentive return and continued strength in all of our business segments, we have raised our FFO guidance for 2006 to $3.55 to $3.65 per share, up from our previous guidance of $3.15 to $3.25 per share.

In addition, given the strength of our global business, we're setting guidance for 2007 for $3.80 to $4 per share.

If you take the midpoint of our 2007 guidance, we will deliver a compounded annual growth rate in FFO over the last three years in excess of 17%.

Strong overall global occupancies, moderate supply growth and increases in construction costs are finally giving rise to rental rate growth.

In fact, our positive rent growth of more than 2% in the quarter is the highest we've seen since the second quarter of 2002.

We continue to closely watch economic indicators.

There are signals that suggest we may be heading towards a slowing in the U.S. economy, but we have not seen a softening in customer demand.

Having our own highly experienced people on the ground talking to people in key markets is critical for keeping supply in balance.

They are an excellent source of market intelligence and their keen insights provide us with adequate lead time, should we need to throttle back activity.

As you've heard us discuss in recent calls, we are committed to becoming the world leader in sustainable warehouse development.

Through innovative design and vendor management programs, we have a mission to focus on sustainability as a core competency.

Global warming has become a top pop -- public policy issue.

Governments from London to Beijing are enacting tougher standards and developers will need to account for the environmental impacts of their projects.

Customers are also becoming a driving force, as they seek to not only reduce their engine costs, but to comply with their company's own social responsibility policies.

We're moving to get ahead of these trends by making sustainability a part of our corporate culture.

We have numerous pilot programs launched around the world.

A recent example is ProLogis Park Amagasaki , a 1.2 million square foot multi-story facility located in Osaka that's slated to open at the end of this year.

We have installed wind turbines to harness the sustained costal winds in the area.

Additionally, we have implemented a rain water recycling program and utilizing new pavement technology that neutralizes carbon emissions from vehicles.

We believe these and other pilot programs around the world will provide with us important data related to the effectiveness of certain initiatives, thereby allowing us to provide benefits to our shareholders, customers, and the environment.

Lastly, I'd like to mention a recent, very exciting initiative in China.

We invested $28 million to become a partner in Szitic, a leading big-box retail developer that has commitments for 40 Wal-Mart stores under planning or development across China.

As in the UK, Europe, and the rest of the world, there are synergies between the development of big-box retail and industrial sites in China, and we believe that this investment will help us as we continue to secure strategic land development sites.

In summary, we are very excited about the opportunities we have to leverage our world leadership position.

We believe our unparalleled development pipeline and equally strong balance sheet will continue to support strong earnings growth well into the future.

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

Thanks, Jeff.

We continue to see positive net absorption across our global markets.

For the quarter, we leased over 23 million square feet of space, with a very strong retention rate on leases turning of about 77%.

Rental rate growth was a positive 2.1%, and our stabilized occupancies were strong at 94.7% leased, with all three continents at over 94%.

In addition, our 6.2 million square feet of development completions for the quarter were 69% preleased, one of the highest quarterly totals ever.

At this point, we feel very, very good about the pace of leasing activity worldwide.

Now markets in North America continue to improve.

The overall vacancy rate declined dramatically to 7.65% in the third quarter from about 8% in the second quarter in the top 30 U.S. markets.

Net absorption in these markets was 46 million square foot in the quarter, bringing year-to-date absorption to 115 million square feet, now roughly on track with last year's pace.

Completions, on the other hand, have totaled only about 98 million square feet this year, so there continues to be a good supply/demand balance.

And absorption has been widespread.

In Dallas, for example, which lagged behind in 2004/'05, we've leased 5.5 million square feet in the first nine months of this year, and our occupancy of over 96% is now roughly 600 basis-points above that market.

We think it's interesting to note that year-to-date net absorption is positive in all 30 markets that we track.

Overall, our North American market officers have been reporting year-over-year market rent increases for the past several quarters of anywhere from 5% to 15%, but we had not yet seen it in our lease turnover statistics, because our in-place rents were historically above market.

That has now changed, as we saw positive rental growth of about 2.5% in our North American portfolio for the quarter.

Given that replacement costs for new facilities are up about 10% to 15% this year and 30+% over the last three years, we believe rents in North America will continue to rise, especially in light of tightening market occupancies.

Now let's turn to Europe.

In Europe, our leasing in our stabilized portfolio was up 50 basis-points to 95.9%.

In the UK, we're beginning to see growth in rental rates reflecting increases in the price of land and construction costs.

Year-to-date, we've leased more than 2.5 million square feet of new developments in the UK, with letters of intent for an additional 1.7 million square feet, and these results basically put us on track for a record leasing year in the UK In southern Europe, stronger economic growth and consumer spending are driving increased levels of demand in France, with supply of new space still in balance.

During the quarter, we signed a build-to-suit lease with Skis Rossignol for 400,000 square feet of space just outside of Leone and another 200,000 square feet nearby Skis Rossignol's sister company, Quick Silver.

Spain is the most dynamic market in the region, due to a chronic undersupply of modern product, and as a result, we've worked very hard to establish new land positions in Valencia, southern Spain, and Madrid, all of which we should break ground on this quarter.

The economy in Germany continues to pick up and market rents are beginning to increase in response to rising construction cost, which we estimate are up roughly 20% over last year.

As a result of German export activity, demand from 3PLs is strengthening and we're now working on a number of opportunities to assist our German 3PL customers with space needs in central Europe.

And Poland continues to be the center of industrial activity in central Europe.

In the third quarter, we signed over 1.1 million square feet of spaces -- excuse me, square feet of leases there, and this brings our year-to-date total to more than 2.4 million square feet, which represents over 40% of all the leasing done in Poland this year.

In Hungary, we're progressing cautiously due to the economic and political situation.

However, the good news is demand is stable and we really remain very well leased there.

Turning to Asia, leasing in our stabilized pool is 97.9%.

In Japan, we contributed four projects to Japan Fund two for total proceeds of $307 million, bringing total properties owned and managed in the Japan Funds to $1.9 billion in just four years.

Our CDFS pipeline in Japan continues to lease up very rapidly, with over 1.2 million square feet of leasing in the quarter.

Also during the quarter, we started development of Narashino 3, a 460,000 square foot multi-customer facility near Tokyo.

And also secured land for the future development of ProLogis Park Ishikawa 2, a 1.3 million square foot facility to be located about ten miles from Tokyo's central business district.

And in China our team is hard at work getting the projects underway that we've announced in recent months.

In the meantime, we had over 0.5 million square feet of leasing in Shanghai during the quarter and continue to make great process in meeting our leasing objectives there.

Overall, we continue to be encouraged by what we're seeing throughout our global markets.

Our pace of new development and leasing is now at a run rate of close to 30 million square feet of new space per year.

Now how are we accomplishing this?

Well, as we've commented on previous calls, an important ingredient is driving repeat business through customer relationships.

Let me give you a quick example of this with DHL.

We currently have 65 leases and 8.0 million square feet leased to DHL throughout the globe.

But in just the last four months, we leased 1.3 million square feet of new development leases with them in six transactions on all three continents.

The leases were signed in Phoenix, L.A., Toronto, the Netherlands, Poland, and China.

We also signed five renewals with them during the same period of time.

This is the perfect example of how we drive growth and this is what gives us confidence in executing our objectives throughout the world.

And now let me turn it over to Ted, who'll talk about our investment highlights.

Thanks, Walt.

The continued strength in global demand that Walt described supported total starts for the first nine months of $1.7 billion.

This development activity will put us at or above the top end of our $2.4 billion full-year expectation and brings us to a record CDFS pipeline of more than $4.6 billion.

On average, those properties are 55% leased, which is very consistent with our pipeline at the end of the second quarter, which was 53% leased.

One key thing to note is that our completed CDFS facilities are over 70% leased, putting us in a great position moving forward into next year.

Our ability to serve customers in key nodes along global supply chains continues to drive new development opportunities.

This geographic diversification also is critical in mitigating development risk.

If you take the top end of our development guidance of $2.4 billion in start this is year and distribute it across our 81 markets, that's an average investment of about $30 million per market.

As we continue to expand our development share in existing markets and establish our presence in critical new international submarkets, we enhance the diversification of our pipeline and better insulate ourselves for those times when certain economies begin to cool off.

Breaking this portfolio down by region, our year-to-date starts in North America of 445 million are in-line with our expectation of 25% to 30% of our total 2006 starts.

During the quarter, we began new developments in Monterrey, Mexico, and in Los Angeles and the central Valley in California, which is becoming a more desirable location due to land constraints in the San Francisco Bay area.

In Europe, year-to-date starts of about 670 million are also in-line with our expected mix.

We began construction of 600,000 square feet of space in two markets in Germany, which are already more than 63% preleased.

European inventory starts included new projects in Stockholm, the Czech Republic, and in London and the Midlands in the UK In Asia, third quarter starts in Tokyo brought new developments to roughly 630 million for the first nine months.

Keeping our land bank full to support future development is also a key priority.

To that end, we acquiring three key sites in Asia, totaling roughly 85 acres in Tokyo, Guanjo and South Korea.

In Europe, we added over 255 acres to our land position at strategic locations in Prague, Warsaw, southern France and the Netherlands.

And in North America, new land acquisitions included sites in Atlanta, the Inland Empire, Nashville, and Reynosa, Mexico.

Recently, you may have seen news articles about the state council in China issuing new guidelines to local governments to regulate industrial land prices.

We had been anticipating this and thus we're not surprised.

In fact, we've been building land positions over the past year, which minimizes the impact to us.

We believe overall industrial land prices will go up as a result of these guidelines, and in the long run, we expect the transparency of land sales to benefit companies like ProLogis.

Also, market rents should increase to accommodate the increases in land cost, which is something we're currently seeing in the U.S.

Since we've exclusive joint ventures at our projects in Lingang and Suzhou these will not be impacted.

Meanwhile, we may accelerate some land acquisitions in China to take advantage of today's favorable pricing.

Looking at our mixed use and redevelopment business, during the quarter, we completed the sale of the L.A. air force land to a residential buyer and recognized an additional $8 million in proceeds, bringing the total pretax gain from this transaction to ProLogis of $35 million and net after-tax gain of $20 million.

This project is an excellent example of the significant value we can create with these types of projects, and we will continue to pursue similar opportunities in key markets around the globe.

In summary, our development business continues to be strong and we have excellent land positions to support our pipeline moving into next year.

And now I'll turn it over to Dessa

Thanks, Tad.

For the third quarter, we reported $0.79 of FFO per share and $0.55 of earnings per share.

This is after $0.03 per share for costs related to the European IPO.

Without those costs, FFO per share would have been $0.82.

As Jeff noted, these are expected recognition in the fourth quarter of the promote related to our European property fund IPO and the continued strong performance in each of our business segment.

We are raising our guidance for full year FFO between $3.55 and $3.65 per share and $3.20 to $3.40 in earnings per share.

As Jeff mentioned, the primary driver behind our increase in FFO per share guidance is the incentive return that we crystallized in the PEPR IPO.

The total amount of the incentive is based on our earning 20% of the up-side after our investors receive a 12% IRR on their investments.

The final calculation is measured by the average price of the stock in the 30-day period following its listing on Euronext, which ended last Friday.

We will receive our payment in two forms.

First, we've received an additional 3.9 million units initially guided at 53.5 million euros or $68 million, which increased our ownership in PEPR to 20.6% to 24%.

Those shares were valued at $73 million at the end of the calculation period.

Second, we are entitled to a cash payment of approximately $41 million over the next several days.

Offsetting this, we paid approximately $4.7 million in fees and netted that against the promote.

We expect that our total net promote will be approximately $109 million or $0.42 of FFO per share.

This is further offset by expenses related to the IPO, which we shared and have incurred in our third quarter of approximately $0.03 in FFO per share.

The successful IPO of the European Properties fund is another example of our ability to create excellent value for both our public and private investors, while also demonstrating our ability to raise capital in a number of markets to substantiate the fund model that we created in 1999.

Essentially, our promote on this fund was earned over the last seven years and, as such, should be looked as a $0.06 [increase] in our FFO per share on an annual basis.

We believe this is a consistent and growing earnings stream, given the fund structures that we have now and are putting in place.

Over the last year, we have reconstituted a number of our fund investments in the vehicles that are open-ended and/or have structures that will allow us to recognize promoted interest along with our investors.

There will be a lumpiness to the actual recognition of these earnings, but it is the value that we are creating on an ongoing and accelerating basis.

Now let me touch on the performance of each of our business segments and the business drivers we watch relative to our guidance, beginning with Property Operations.

Last quarter we noted that same-store NOI growth of 2% to 3% for the year was more likely, and at 2.95% year-to-date we are on track with this increase expectation.

Customer retention stands at over 75% for the year-to-date, ahead of our expectation of 60% to 70% for the full year.

Occupancy in the stabilized properties was down slightly from 95.2% to 94.7%.

The leasing environment remains strong and we are taking advantage of this environment to push rents and further extend lease maturities.

Turning to development proceeds and gains relative to expectations, CDFS dispositions of $1.3 billion year-to-date are tracking to the lower end of our full-year range of $1.7 to $1.8 billion that we revised last quarter.

Our margins continue to be strong, with our average post-tax post-deferral CDFS margin at 22.6% for the year-to-date.

Continued cap rate compression in many parts of the globe give us comfort that the margins will remain strong throughout the year, and thus we are comfortable with our previous range for CDFS profits.

Income and fees from our property funds were affected negatively by approximately $9 million year-to-date due to our shares of expenses related to the PEPR IPO.

Also, as a result of the PEPR incentive fund returns, fees and expenses will now be $205 to $210 million rather than the $95 to $100 million as outlined in our initial guidance.

Last quarter we also raised our guidance for development management fees with income from CDFS, JVs and interest on long-term notes receivable to between $90 and $110 million.

These three line items primarily relate to a number of strategic investments that we inherited as part of the Catellus merger, but they include our JVs in China, Europe, and North America, as accounted for in the [inaudible], as well as the earnings from historical ProLogis redevelopment sites, such as Dartford in the UK Approximately one-third of these earnings are from development activities for which we have no capital invested.

In the remaining activities, we have approximately $470 million invested, which are generating double-digit returns.

While many of these investments and/or projects will mature over the next few years, we expect to continue to grow this business and seek out opportunities where we can augment our earnings by capitalizing on our strong relationships with government entities to increase our share of land development opportunities globally.

At roughly $91 million year-to-date, we expect to be at the top end of our range for these line items.

Regarding G&A, we expect that we will be at the top end or slightly above the guidance for the year of $135 to $145 million that we revised last quarter due to the continued growth of our business and, as noted last quarter, the need to attract, pay, and retain talent in the current market environment.

Given our purchase of the portfolio of Mexican assets at the end of the second quarter and an increase in debt to support our expanded pipeline, we expect net interest expense and preferred dividends to increase by approximately $15 to $20 million for the years to a total of $300 to $330 million.

These increases are being offset by increases in rental revenues.

Our balance sheet remains strong, with total debt-to-capital 39.1% on a market basis.

Our percentage of floating rate debt has increased to 30% to 38% due to our strong development pipeline.

Most of the interest on this debt is capitalized and this does not have a significant effect on our bottom line.

Finally, turning to our guidance for 2007, the continued strength of our all of our operating segments, combined with our large, well-leased development pipeline and visibility in continued strong markets, gives us confidence to set a range for 2007 of $3.80 to $4 of FFO per share.

We expect to end 2006 with a strong relief pipeline of over $5 billion.

That pipeline today has approximately $2.6 billion of completed and repositioned assets that are 73% leased and will be ready for contribution during 2007.

In addition, we believe that we will continue to see strong margins, as many of these projects benefit from having been started over the last nine to 24 months,, before some of the rapid rise in construction costs and will benefit from today's prices.

This pipeline gives us confidence that we will grow CDFS profits substantially in 2007.

At the same time, strong contributions in 2006 and 2007 will drive our base fund fees, incentives and returns, which will continue to grow at a rapid pace of more than 20%, before taking into account any promotes or fund liquidations or reconstitutions for either 2006 or 2007.

Our 2007 guidance does not include the recognition of any promotes or incentive returns.

In addition, we see continued growth in our leasing and solid occupancy, indicating that rental growth will remain strong in 2007, as it was in 2006.

As some of our strategic investments roll off and we invest in new projects, we expect that the development management interest and other income to be less robust in 2007 than it was in 2006.

Finally, we have spent this year increasing our staff and investing in our people to be able to continue to capitalize on the opportunities that we have.

We expect that our G&A will grow slightly in 2007 to keep up with the pace of our global expansion, but that we'll get operating leverage from the platform we have built.

As is our custom, we will give you an a detailed analysis of our business drivers in early 2007.

Thank you.

We are excited about finishing this year strong and look forward to an excellent 2007.

Operator, we are ready to take questions.

Thank you. [OPERATOR INSTRUCTIONS] Our first question will go to Ross Nussbaum at Banc of America.

Please go ahead.

Good afternoon, everyone.

A question on the CDFS pipeline for 2007.

Dessa and Walt, you'd comment that $2.6 billion had been completed.

I'm assuming that's not the total you're guiding us to for total contributions next year, is it?

No -- we're not giving you any detailed guidance on next year.

What we're giving you is an indication that we do have amount available for contribution in 2006, with strong margins.

And I'd say, Ross, that if you look at where we are at $2.6 billion at 73% leased and compare that to where we were just nine months ago -- and this is just the completions, forget about what's under development -- we had $1.4 billion completed nine months, which was 58% leased.

So what we're really saying is, look, we have over $1 billion more than of assets that are complete that are 15% higher leased than they were last year, so that's what gives us great visibility moving into next year.

Our next question will go to James Feldman at UBS.

Thank you very much.

Can you talk a little bit about the growth rate that you've set now for '07 and why you have confidence that maybe it should continue going forward?

Or is this really the sweet spot of the business model?

James, I'll start that and if anyone else wants to jump in, they should feel free to.

But obviously, as Walt just noted and Dessa noted, we feel like we have great visibility into 2007.

Our teams around the world have done an outstanding job ramping up our development starts, but more importantly, ramping up our leasing and effectiveness on marketing to our customers on a global basis..

We're seeing increased leasing activity, as well as those starts, so the lease -- our pipeline is better leased than it's ever been.

And we feel very good about 2007 and that rolls well into the way things are today, in today's business environment, strong growth going into 2008.

The only thing I would add to that, James, is I think that, if you look at how we've grown in the last five years, we've basically penetrated additional markets and thenwe've penetrated submarkets within those additional markets.

And, frankly, we all feel pretty good about growing our market share in the markets that we're in.

At least in the terms we look at it today, we think there's an incredible amount of growth in the years ahead.

We'll go next to Jay Habermann at Goldman Sachs.

Please go ahead.

Good morning.

Just a quick question on rent growth.

Walt, you mentioned the 2.1% from the quarter.

Can you just look at where rents are today versus where they're expiring in '07 as well as '08?

That's a good -- that's a really good question, and it's something that we talk about a lot internally.

I think moving into the year, we all kind of felt that rents in place were about at market, maybe just slightly below -- the rents in place probably had -- were slightly above market, and that is completely reversed itself.

We're beginning to see much stronger rental growth now.

Clearly, the rents in place have up-side at this point in time, and that's obviously a lot different than last year and the year before.

Hard to say exactly what, but I think the 2.1% begins to show you what it looks like on a snapshot basis.

But market rents are up 5% to 15% this year, and so I -- I mean, candidly, I think looking at next year, we would think that the number would be higher, but we don't exactly know what that number's going to be at this point in time.

And I'd say rents are probably anywhere from 3% to 5% potentially below market today.

We'll go next to Lou Taylor of Deutsche Bank.

Thanks.

Good morning.

Could you guys -- Walt, maybe just comment on, you had a higher level of CDFS sales to third parties in the quarter.

Can you give some color whether the margins on third-party sales are above or below your averages?

Yes.

As far as -- we have -- as far as the average they're kind of in line with our general average.

I would say that in certain markets in the world, we're having higher margins, places like Japan, we've tended to have higher margin, but our overall our third party sales have been relatively in-line with -- on an average, with where we are across the board.

Lou, just so you know, we did have a couple third-party sales.

One of them was a condemnation of assets in Chicago for the fifth runway at the airport.

And that's -- when you look at the supplemental, you'll see that coming through.

And another one was the sale of a building in the UK.

It was a big number, but it was the sale of a building.

And it was not a strategic building to us and we didn't recommend that the fund buy it.

Really, you're talking about only a couple buildings that were out there, so even if we were to give you the breakdown of the margins, it would be statistically insignificant.

And we'll go next to Chris Haley of Wachovia.

Please go ahead.

Good morning, it's Brendon Maiorana with Chris.

A question again on the CDFS margins.

Dessa, you mentioned that part of the reason why you guys are getting strong margins is due to construction costs, which are lower than current construction costs.

Wondering if you can comment on how much you think your stronger-than-expected CDFS margins are attributable to those lower-than-market construction costs versus cap rates, which may be lower than you originally expected?

I think it's a combination of both of those.

We underwrite to the current market conditions when we underwrite.

And then before we put anything into the ground, we have actually have a construction contract in hand before we put it into the ground.

We fix those hard costs.

Coming out of the period, the cap rates may have changed, the rental rates may have changed or not changed, based on the market at that time, So it's kind of a combination of cap rates coming down and the construction costs that are increasing -- the older construction costs increasing our margins.

Ted, you might want to comment on what's happening from that perspective.

One of the cost components of our developments is clearly the land.

The land is probably where we're seeing some level of benefit.

Land that we bought 24-36 months ago clearly is more valuable today than it was then, with cap rate compression.

I think, as Dessa put it, it's a combination of things.

We've also said it's a mid to high-teens business and our margin certainly reflect higher margins than that and it's a combination of things.

If you're trying to calculate what's our further up-side in our pipeline, we're going to continue to guide you to the mid, high teens as profit margins and we have, so far, consistently outperformed that.

But long term, that's how we operate our bus -- we operate our business based on what we perceive to be reasonable, sustainable profit margins.

I'll go next to David Fick at Stifel Nicolaus.

Hi.

I'm tempted to ask if Jeff could talk a little faster, but my question is, why is the Szitic deal synergistic, and if it is there, why shouldn't such co-investments in other markets make sense?

David, in China, particularly, we're looking at large tracts of land,land that's controlled and ofttimes by government entities.

And they have -- one, there's a true synergy -- there's value added in controlling larger sites with the ability for Szitic to take the front of that site for big-box retail development, for Wal-Mart development and us taking the back of the site for outstanding location distribution development.

Actually, there was a lot of people interested in making the same investment in Szitic that we did.

It wasn't a matter of price.

People had offered them higher prices, but they saw a strong synergy to them of tying up ProLogis, given our presence, given the fact that we have offices in twelve markets across China today, that we have established a market-leading position there.

We have 160 people in place, and the successes we've had to date made us attractive to them, as well as them attracted to us.

We'll go next to Matt Ostrower at Morgan Stanley.

Mr. Ostrower?

In the supplement, the development costs per square foot in Asia and the other regions, as well, went up pretty significantly, looks like they almost doubled in Asia.

Can you address is that?

Is that a mix shift or is it construction costs themselves?

Matt, that's a mix issue.

In Asia, it is very skewed towards Japan.

As a matter of fact, I don't think we had any starts in China for the quarter at all.

And in the UK -- excuse me, in Europe, it is very skewed by the UK.

Over 50% of the starts in Europe this quarter were from the UK.

And the price per pound -- or the price per square foot in the UK is roughly double or more what you see on the continent.

We'll go to Paul Morgan at Friedman, Billings, Ramsey.

Morning.

Can you just talk a little bit more about the Chinese regulations.

You mentioned that you might accelerate some acquisitions.

Does that mean you've prenegotiated land acquisitions that wouldn't be subject to the new price hikes?

And then whether it has maybe changed your appetite for entering new markets at the same pace you were contemplating previously?

This is Jeff.

I'll start that question and then I'll turn it over to Ted.

All of us have worked very closely on this, because it's an important initiative to us.

What we're talking about doing is potentially taking down some of the land we've secured with fixed price options in the past.

We were aware of the potential for this type legislation passing, and that's why we accelerated our program to tie up the most strategic sites in China, in our opinion, and tie up long-term options at fixed prices.

We'll accelerate, potentially taking down those options, so that we secure these sites is at what are today very attractive pricing, but we think will be even more attractive pricing with the new regulations in place.

We're pleased that we adopted the strategy we did two years ago.

We thought this might be the case.

It did turn out to be true, and puts us in an even stronger position.

Ted?

And in response to entering more markets in China and newer markets, our business is built on being able to buy land at fair market value and develop properties based on sustainable profit margins and I think that there's no secrets to it.

We're out there, we got into China early, so we are in a very favorable position.

But our scope and scale and what we're doing throughout the world really provides us with benefits in leasing customer relations and those are the ways that we really enhance our business, enhance our yields.

We're not reliant on buying market at -- or land at below market pricing.

We will absolutely enter new markets in China.

We think transparency in sale pricing is a good thing.

We happen to be in an advantageous position for quite a few strategic locations in China, I guess we want to make you aware of that.

But for the balance of the country, we're going to compete and acquire land at market value.

I'll go next to Jonathan Litt at Citigroup.

I wanted to better understand the average age of the pipeline.

You've got $2.6 billion in completed -- or almost completely completed developments to contribute.

You've got another $2 billion that's under development.

I guess it's really more like $2.5 billion, based upon your comment about the pipeline.

What's the average age of the completed and what's the average age of the underdevelopment?

I'm trying to get a feel for how much of that underdevelopment could move into completed in the next six to 12 months?

Do you want to do it?

Well, I can start.

Go ahead, sure.

Let me start.

First of all, looking at the -- if you look at how much we had completed a year ago, that's probably the best way of getting there.

Looking at the $1.5 billion that was completed a year ago, we're now at $2.6 billion.

That is -- those properties have come on $1 billion of that over the last year.

At the same time, we've contributed $1.3 billion of assets over the last year.

So that's come out of that development and we knew it was coming.

What I would say to you is that the average age of the completed is probably -- for the most part is less than a year, because anything over a year, we begin to look at differently and it starts to go into the pipeline -- into the contribution at that point.

And then the new stuff, you've seen it come on and that average age is probably in the six month -- three to six month range.

And Walt, if you want to --

And John, let me just add to that.

In Europe, the arrangement was that we contributed within -- I believe it was six months of completion -- or after leasing, I should say.

The arrangement in Japan is the same.

And the arrangement in the -- with the new North American fund is nine months.

And so, basically, we just can't be sitting there with leased up developments without contributing them to the funds, so Dessa's absolutely right.

You have $1 billion that have been added to the pool that is far less than a year, and then you probably have the remainder of it that can't be, by definition, much more than a year.

So the pipeline is pretty much all new assets.

Now the only caveat to that would be repositioned acquisitions, which obviously are, by definition, have age when you buy.

We'll go next to Cedric Lachance at Green Street Advisers.

Please go ahead.

Thank you.

You think the PEPR example, perhaps -- can you walk we through how you think about rolling your JVs into infinite live vehicles, whether you prefer to do that in the public market versus the private market?

Cedric, it's Jeff.

I'll start that, and if anyone else wants to jump in.

It starts out by saying whatever creates the best opportunity and the greatest value creation for our investors, both private and public investors.

I know that's not a direct answer to your question, but there isn't a simple answer to it.

The best answer, when we restructured -- or recapitalized funds two, three, and four in North America was another private equity fund.

It was an infinite life fund.

It was a structure we really liked, a structure that investors obviously liked, which raised a great deal of capital.

The capital supported our development business in North America for the next three years in doing so.

In Europe, the best structure we felt was a public structure that created an infinite life structure and gave liquidity to our current investors and accomplished our requirements.

It will be a major investor going forward in our new private equity funds in Europe, as we create them.

And again, that was the best answer, the best structure there.

I guess the takeaway is that we are going to continue to be creative in the way we structure our funds and the way we finance our business.

We're going to try to do things in the most advantageous manner.

And the public equity and the private equity markets are constantly evolving, constantly shifting and at one moment in time, one may be more advantageous than the other and we want to be nimble enough to take advantage of those shifts.

And we'll go next to Michael Mueller at JPMorgan.

A quick question on occupancy.

Looks like the overall portfolio occupancy ticked up sequentially, but if you look at the stabilized portfolio, it dipped down, I forget the exact number, maybe 50 basis-points or so from Q2 to Q3.

Looks like it was driven by North America and Japan.

Just wondering what was driving that?

Mike, let me address that.

There was really -- this's a couple things.

One, if you'll notice that we made acquisitions of 200 and some odd million dollars for the quarter that were pretty far underleased.

I'll get it in front of me.

Something like 40% or 50% leased.

And secondarily, we did have one building in the Midwest, which was about an 800,000 square foot move out at the end of the quarter -- yes, right at the end of the quarter, as a matter of fact.

We have leases out for signature of that building for 83% of the building right now.

So what you're really talking about is really acquisition driven and a fairly isolated case that we feel pretty good about releasing at this point.

Our next question will go to Sri Nagarajan at RBC Capital Markets.

Please go ahead.

Thanks.

The question had to do with the PEPR.

I think Jeffrey mentioned that you were eligible to earn incentive fees after two years.

I was wondering whether the incentive fee structure, number one, in PEPR was pretty much the same as before the public IPO?

And number two, any restrictions in terms of the -- and outside of the usual regulatory requirements in reducing your ownership levels with PEPR?

Thanks.

Sri, let me answer that two-part question.

I believe the first question related to our promote and was it the same as the pre-IPO promote.

It's very different, the incentive fee.

It's on a rolling three-year basis, that's how how that's structured.

Two years from now with a three-year look back.

And it's based upon a return to our investors above 9% compounded -- compounded total return on NAB.

And we earn 20% above nine every three years -- every year, but on a three-year look back starting two years from now.

It will be an annual potential for creating a promote.

So we're really creating a better stream, more of a annuity and something that will be far more consistent -- although the value created may be similar to what we created over the last seven years -- it'll be recorded and recognized on a more consistent basis.

And we think the investment community will ascribe more value to that, although, as Dessa argued, I think effectively you really look at this promote that we earned this quarter -- or earned in the fourth quarter or will be recognized in the fourth quarter, it's really been earned over the last seven years.

And our earnings over the last seven years, real earnings, have been higher than what we've reported.

The second question had to do with our regulatory requirement to own shares.

The regulatory requirement is very low, obviously.

However, we've covenanted that it will never go below 10% ownership.

We're currently at 24%.

We've also covenanted to the investors that for the next two years we won't go below 12.5%..

We're well above that today.

We're very comfortable with the investment, but there is a great deal of value in our investment in PEPR.

We'll go to Jay Habermann at Goldman Sachs.

Hi, just a follow-up.

The $1 billion of properties you've acquired from third parties and roughly two-thirds of that is held 100% by ProLogis, can you give us a sense of the yields, where you expect them to go and the amount of capital you may have to invest in those assets?

The $1 billion is -- a number of that is the Mexican assets that we acquired at the end of the second quarter and those assets will be ones that have -- I don't know that we've reported yields on those, but they are probably higher than our average yields, given that it's in Mexico.

Those are the primary -- that's the primary piece of that.

Yes, and let me make a comment, because I think it's a broader -- I think there's something broader we should also talk about.

Remember that early this year, late last year after we had completed the Catellus merger, we had roughly $750 million of dispositions that we had said that we wanted to dispose of.

These are noncore assets that Catellus -- I mean they're great assets, but they're just noncore for us.

They were mainly office and retail properties and a hotel.

We have disposed of those assets -- just about done disposing of those assets at roughly a 6.4% to 6.5% cap rate.

Keep in mind, this includes hotels, this includes office buildings.

In my view, properties that have much higher TIs and probably a different risk profile than we're willing -- or than we have in our portfolio.

We have turned around and reacquired properties that have been purely industrial properties at somewhere in the neighborhood of a 6.25 cap rate.

We expected on our merger call that we would have closer to 100 basis-points of dilution associated with that.

I think what's happened in the last year is that there's enough capital out there that, frankly, those yields have compressed, those cap rates have compressed.

We've been a direct beneficiary of that, vis-a-vis our expectations a year ago.

So if you look at any one particular quarter, I would think you just look at the entire year.

And other than what Dessa said, which was over a $200 million acquisition in Mexico at higher yields than that, in essence, we've redeployed the capital in North America, somewhere in the neighborhood of 6.25.

We'll now go to Christopher Pike at Merrill Lynch.

Hey, Walt, a quick question.

In terms of Asia and specifically Japan, sounds like land is becoming more scarce, especially closer in the harbors and major logistic hubs.

What we're hearing is that this is pushing -- and I think as you guys indicated -- demand out further.

How does that impact, if at all, pro forma caps and margins compared to what you're currently contributing properties at now?

One thing I would say, Chris, is that the rental rates associated with what we are developing properties at are also higher.

So construction costs are higher, land prices are higher, yes, they're more scarce, but we're also seeing rising rental rates.

So basically, if you really think about it, you got everything is basically just adjusting up.

Having said that, back to Ted's comment, we've been underwriting at certain spreads and those spreads have been better than that, because cap rates have come down.

But we're not underwriting to those high spreads today, we're underwriting to more reasonable spreads, given land prices and where we think we can lease and where we think we can sell those assets, or contribute those assets.

Ted?

Yes, one of the other components to some of these higher spreads isn't just lower cap rates.

In the markets that you're referring to, the ones that are closer into ports, we're actually seeing a significant rise in rental rates, and we're actually picking up quite a bit on margin because of increased rental rates in certain markets.

It had historically been primarily cap rate compression, but more recently we're seeing what we would expect in a more highly sought after locations, rental rates are going up, and we've been a beneficiary of that in certain markets.

We'll go now to Lou Taylor, Deutsche Bank.

Thanks.

Can you guys comment on the North American fund that was formed in February?

What kind of inflows or outflows are you seeing in that fund recently?

Lou, no outflows because essentially what we have is a three-year subscription agreement with investors and I don't think anybody is interested today in buying assets and then reselling them four to five months after that, because they really want to deploy their capital., so there's no outflows.

On the inflow side, what we've had is -- you know, we had the funds two, three, and four that initially went into that.

That was the end of the first quarter, beginning of the second quarter, I believe.

And we've had contributions -- quarterly contributions since then and we'll continue to make contributions into the fund moving forward.

And the fund itself expects that we're going to make quarterly development contributions moving forward.

It's a $4 billion fund -- and I'm rustling my papers right now to get to the exact page -- but I'm going to say there's what?

About $1.3 billion or so that has been contributed this year.

Think of the subscription period being over three years and so I think we're dead right on track as to where they'd like to be.

Lou, if your specific question was in-flows, out-flows as it relates to equity contributions, we're fortunate -- Ken did an excellent job executing on that -- and we raised sufficient capital initially to fund our business for three years.

We didn't do it in a piecemeal fashion.

We had so much investor demand that we raised enough capital from very, very significant, very important investors around the world to fund the business for three years.

We're not out actively seeking capital for that.

It is current -- although it is an open-ended fund, we are currently not soliciting any new investors.

And we'll go next to David Harris with Lehman Brothers.

Thanks.

Dessa, could I just go back to your comments on the guidance for '07 with regard to CDFS.

Is CDFS business likely to produce a larger percentage contribution to FFO in '07 versus '06?

And collectively, you guys seem to be suggesting that pru -- on the basis of prudence, we ought to be looking at margins on the CDFS business, as we look into '08 being 300 or 400 or even 500 basis lower than you're likely to be booking in '06 and '07.

Yes, I think that -- first of all, I do think contributions from CDFS will be higher percentage basis, just given the overall growth in both that business and our development business and the fact that we have a good strong pipeline in place.

I think that the margins will come down slowly over time.

They will come down and that will continue into '08, '09, we'll continue to see some decrease.

The really important aspect of this, however, that I don't want to lose sight of it, that as we contribute those assets into our funds, we create a new stream of earnings of funds, fees and returns.

That line item is actually our faster growing line item, as a whole.

But we're going to keep see -- in a normalized environment, we're going to keep seeing 18% to 20% type of growth in that line item, just by the continual contribution of assets.

If you were thinking even a $2.5 billion sort of pipeline, we should be able to keep that growing that growing at 18% to 20% over the next few years..

We're talking about a higher potential pipeline -- a higher pipeline here, and that means that line item's going to grow quicker now and then when CDFS potentially stabilizes a bit at some point in time, it'll continue to grow quickly.

Operator, I know we're running short on time.

If we could take two more questions, that'd be great.

Very good, thank you.

We'll next go back to Jonathan Litt at Citigroup.

I wanted to follow-up or clarify on Ted's comment.

He talked about construction costs and that the land component, but I guess I'm curious about the nonland component and what's happened on that side?

A great question.

Last year we saw substantial increases in construction costs.

We projected that would also occur throughout this year.

However, very recently -- and I mean in the last 90 days -- I think we've seen a cooling off in the escalation of construction costs and are projecting for a much smaller increases in construction costs between now and year end -- really the second half of the year -- than what we experienced in the first half of the year.

The land costs have continued to rise, but actually construction costs are starting to level off.

Within North America.

Within Japan, we're still seeing some significant increases in construction costs.

We've been fortunate, however, in that we've got our own in-house engineers, designer, the same people that designed our seismic isolater that you saw a few years ago, Jonathan, have been able to value engineer our buildings using that seismic isolation technology to keep our costs in line or, actually in some cases reduce our costs, but we've seen costs go up 10% over the last six months in Japan.

And our final question will go to Ross Nussbaum with Banc of America.

Please go ahead.

Squeezed in.

I want to follow-up to a question that Jon Litt asked earlier, which is if I look at the average age of the land underlying the $2.6 billion of completed assets in the pipeline versus the average age of the land on assets you sold in 2006, how does that compare?

Ross, let me answer that by saying that first of all, when you are building $2.5 billion of developments per year, roughly 30% to 40% of that new development is in land, right?

So let's say $2.5 billion at 30%, you're at $750 million.

So let's call it $750 million to $850 million probably is the number we put into service every year.

Our land bank is $1 billion.

If you look at the land bank, it's a little -- it's obviously skewed.

You've got $600 million in North America and $160 million in Japan, because you're not really banking much land in Japan.

I'm going to tell you we have in essence of a little bit more than a one-year supply, but that's not exactly true because what we really have is call it a three-year supply in North America and almost no supply in Japan, because you buy land and put it into service immediately.

But my point is that we're not -- we don't have a ton of acreage that have been sitting around for more than a couple years.

We bought it a couple years ago and then we're putting it into service.

We have more of that in the U.S. than we do than Asia, and Europe is somewhere in between.

So that $1 might be under valued by 10% to 20%, but it's not undervalued by 50%.

I think some of what you're getting at is how much valuation do you have in the land moving forward, and there's clearly some, but we're chewing through the land more rapidly than might meet the eye.

Our land bank isn't that significant from a number of years standpoint.

And remember, we picked up a fair amount of land from Catellus, about $300 million that was mark-to-market at that point, so if you're looking at the valuation, you have to realize that was mark-to-market last year.

That does conclude our question-and-answer session.

I would like to turn the call back to Mr. Schwartz for any closing comments.

Thank you.

I'd like to take a moment to thank everyone that was on the call today.

Obviously we're very pleased with our third quarter.

We're very pleased with where this year looks like it's going to end up.

We're equally or more excited about the way 2007 is shaping up and what our guidance looks like in 2007 rolling into 2008.

I'd like to say that we really appreciate all of your support and we appreciate the hard work that was done by all of our people around the world to create these kind of results.

Everyone, our teams in Europe our teams in Asia, our teams in North America, we're having a phenomenal year.

North America's doing significantly better than we've done in a number of years, and it's due to the leadership of our North American leadership team is doing a great job.

Dessa, Walt, Ted, Melissa, and myself look forward to seeing most of you in NAREIT and have a good couple of weeks and we look forward to seeing you in two weeks.

Thank you.

Thank you.

That does conclude the call.

We do appreciate your participation.

At this time you may disconnect.

Thank you.