Prologis Inc (PLD) 2006 Q4 法說會逐字稿

Good morning.

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

I would like to welcome everyone to the ProLogis fourth 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, ma'am.

Thank you, Deana.

Good morning, everyone.

And welcome to our fourth quarter and year-end 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'll first here from Jeff Schwartz, CEO, to comment on outlook and our sustainability initiatives.

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 would 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 would also like to add that the fourth quarter results press release and supplemental do contain financial measures such, as FFO and EBITDA, that are non-GAAP measures, and in accordance with Regulation G, we have provided a reconciliation to those measures.

And, as we have done in the past, to give a broader range of investors and analysts the opportunity to ask their questions, we will ask you to please limit yourselves to one question at a time.

Jeff, would you please begin?

Thank you, Melissa, and good morning, everyone.

We are very pleased to report strong results for the quarter, while achieving a 36.5% increase in full-year FFO per share over 2005. 2006 was a year of significant accomplishment for ProLogis.

From the strong improvement in our operating fundamentals, to the expansion of our global development pipeline, to the successful realization of embedded gains in our property fund business, our teams executed extremely effectively this past year, a standard which we intend to continue.

While some observers have voiced concerns about the potential for a slowdown in our sector, we're seeing no such signs.

There has not been any discernible slackening of customer demand.

We continue to experience strong momentum around the globe, with the record pace of leasing activities seen in 2006 continuing into the first quarter.

We capped off the year with a fourth quarter rent growth, same-store NOI growth, and same-store occupancies at their highest levels since the second quarter of 2002.

This morning we introduced the business drivers that support our guidance for 2007.

Dessa will have more on the specifics, but I would like to focus on our expectation for accelerated development activity.

We plan to start roughly $3 billion to $3.3 billion of new developments this year, an increase of 20% to 30% over 2006.

The growth in our development program is supported by the strength and depth of our global platform, customer relationships, and organization.

Consider that over the past two years we have expanded from two to five markets in Japan, from four to 12 markets in China, to ten additional markets in Poland, Germany, and Spain, moved from a distant number five in Mexico to a strong number two market position, entered Canada, and importantly, 2007 will be only the second full year since our Catellus merger, with the full synergies still being realized.

Clearly, we have tremendous opportunities to expand our business platform in existing markets in which we already have leadership positions.

In fact, those markets we're already in represent over 76% of world GDP.

And we have the operating platform, customer relationships, and strategic land positions necessary to capture a greater share of the development business and customer mind-set in these key logistics markets.

Ted will have more on our strategic land acquisitions shortly.

Of course, we continue to watch economic indicators closely.

There have been mixed signals related to the U.S. economic outlook, but customer demand remains solid, driven by growth in global trade.

In Europe and Asia, we're also seeing strong demand in the majority of our markets.

Looking at port activity as a barometer, with 17 of the largest 20 ports in the world having reported 2006 results already, we have seen an average of 12.5% growth in container traffic.

Thus, we expect to see the growth in global trade once again far outstrip global GDP growth.

In addition to monitoring global economies, we also rely heavily on our people on the ground.

Their interaction with customers and ability to monitor local market supply and demand in realtime are critical elements in our capital deployment decisions.

The bottom line is that we have solid systems and processes in place to make sure we remain appropriate and disciplined, while growing our platform.

Now, let me shift gears and address another topic, one that we've discussed on a number of recent calls and is now a major area of focus for the Company.

As you've heard us say previously, we're committed to becoming the world leader in sustainable development by reducing the environmental impact of both new and existing facilities in our portfolio.

Just yesterday, we announced that we've become the first real estate Company in the world to join the Chicago Climate Exchange, or CCX.

The Exchange is a voluntary organization that enables companies to reduce net greenhouse gas emissions through the trading of carbon credits, just like any other commodity.

Our membership requires us to offset the carbon footprint associated with our business operations in the U.S.

We've also earned tradeable credits as we build warehouses that reduce energy consumption through new technology and high quality design.

Joining CCX has helped us become more disciplined in measuring and quantifying carbon output in our developments and owned facilities.

The additional value we'll capture from the trading of credits doesn't represent a meaningful dollar amount at this time, but it does help us establish energy efficient building as a core competency, and further positions us as the global leader in this area.

Between this program and other initiatives, such as replacing lighting systems in our North American facilities with more efficient equipment, we'll help our customers reduce energy consumption.

Over the long-term, we believe having more energy-efficient buildings will become a competitive advantage, especially as our customers seek to implement their own sustainability initiatives.

Also, in keeping with our commitment of sustainability, which we believe transcends energy and carbon into the very fabric of our communities, we substantially increased the size of our ProLogis Foundation with a $5 million contribution in the fourth quarter.

The Foundation allows us to give back to the communities in which our associates live and work.

In summary, we are extremely pleased with the strength of our business, the expansion of our development pipeline, and our associate's demonstrated ability to deliver value for our customers and shareholders.

We will continue to explore new ways to leverage our world leadership position through strategic and synergistic initiatives, and hope to have some exciting new developments to talk to you about in the near future.

We remain exceptionally well situated as we move into this year, with a strong financial position and expansive pipeline of opportunities.

Strong market conditions and continued strength in global customer demand support our confidence in our combined and continued ability to generate solid growth in all three of our business segments.

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

Thanks, Jeff.

We had an extremely active year from an operations standpoint, with record leasing of more than 102 million square feet during 2006.

That includes both first generation leases on new development space, as well as renewals.

But in total represents activity equivalent to more than a quarter of our total operating portfolio.

Retention of 78% for the quarter and 76% for the year was at the strongest levels in several years.

Rent growth on turnovers was 5.6% for the quarter and 1.7% for the year, compared with negative 1.5% for all of 2005, reflecting steady improvement throughout 2006.

In our stabilized portfolio, leasing was strong at 95.3%, with Asia at 99%, Europe at 95.4%, and North America at 95%.

And our 30 million square feet of developments completed in 2006 were 69% leased at year end.

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

Now, markets in North America remain strong.

The overall vacancy rate was stable at 7.6% in the fourth quarter in the top 30 U.S. markets, unchanged from the third quarter, but 50 basis points below where it was a year ago.

Net absorption in these markets was 33 million square feet in the quarter, bringing full-year absorption to 149 million square feet, a 3.1% increase in total occupied space.

The pace of absorption moderated last year compared with 2005, but was still in excess of supply of 136 million square feet, demonstrating that supply and demand remain in balance.

And we've now reached the point where we're consistently turning over below market leases, resulting in rental growth of 5% in our North American portfolio for the quarter, and 2.6% for the year.

With replacement costs up 30% to 50% over the last three years and tight market conditions, we expect rents in North America will continue to rise, especially given what we're seeing in the way of incremental demand in our markets.

And we could not be more excited about what we're seeing in Mexico.

There the market for Class A space is growing at 8% to 9% per year.

And with our expanded presence into Mexico City and Guadalajara announced earlier this year, we expect to double our development starts within the next two years there, making us the largest developer of distribution facilities in the country.

Now looking at Europe, Europe had very strong leasing activity throughout 2006.

Europe continues to experience dramatic cap rate compression, which has held down rental rate growth, especially in central Europe.

However, capital growth has been very, very strong.

Rental rates in the UK have been stable over the last three to four years, despite cap rate compression.

Now this is because entitled land in the UK has always been scarce, and new supply is extremely hard to come by.

Given how tight the market is and how rapid costs have escalated there, we expect to see strong rental growth in the UK going forward.

Leasing activity in the UK has also been brisk.

For the year, we leased more than 4.3 million square feet of space, and we also enhanced our customer service platform by bolstering our land positions, which Ted will have more to say about in a moment.

In central Europe, we continue to capitalize on rapidly expanding markets.

In Poland, we leased more than 3.5 million square feet of new CDFS space in 2006, 75% more than in 2005, as we further penetrated more market share and extended our presence into additional markets, as Jeff talked about.

We estimate that now we have a 33% market share of the development market in Poland.

During the quarter, we leased space in Poland to repeat customers Johnson & Johnson, Iron Mountain, and Wincanton.

And we also leased space to both Iron Mountain and Wincanton in Hungary in the fourth quarter, where activity has picked up as the political situation there is stabilizing.

And earlier in the year, we signed our first lease in Romania with Kuehne & Nagel, a major customer in Europe and North America.

Now, turning to Japan, during 2006 we had development starts of over $650 million, representing approximately 6 billion square feet of space.

In the fourth quarter, we broke ground on a 292,000 square foot facility for a repeat customer, Nippon Express, who will be using the facility to provide logistic services to Nike.

Now this is our 18th lease with Nippon Express, and is a true testimony to the power of our operating model.

We continue to achieve full leasing in Japan at, or shortly following completion, and have an impressive pipeline of over $0.5 billion of stabilized facilities that we anticipate will be contributed to our Japan Fund II.

In China, our team is hard at work advancing the projects that we've announced in recent months.

In the meantime, we leased over 3.7 million square feet during the year, bringing our total stabilized occupancy to 97.7%, and are making great progress in meeting our leasing objectives overall.

Transactions in the fourth quarter included our 63rd lease with DHL, who will occupy 200,000 square feet in a newly developed warehouse at ProLogis Park Lingang, located outside of Shanghai, adjacent to the Yangshan deepwater port.

Our completed projects at this strategically-important port are now 100% leased.

Overall in China, we're building upon our global customer relationships, where repeat customers now include Adidas, L'Oreal, Nokia, NYK, Samsung, and UPS.

In summary, we continue to be very encouraged by activity levels driven by global trade throughout our markets.

And in fact, in talking to our customers, we believe the pace is increasing.

During this extraordinary time of growth, we believe our global footprint and strong customer relationships will serve us well.

A recent example of this is with Whirlpool, a top 25 customer.

We signed three leases with Whirlpool in the quarter, in Mexico City, Monterrey, Mexico, and the Inland Empire totaling 933,000 square feet.

We also serve them in Warsaw, and right here in Denver.

This is a great example of how we're driving growth and what gives us confidence in executing our objectives throughout the world.

Now let me turn it over to Ted, who'll talk a little bit about our investment highlights.

Thanks, Walt.

The continued growth of global demand that Jeff and Walt described supported record starts for the year of more than $2.5 billion, putting us above the top end of our $2.4 billion expectation.

Breaking this down by region, the activity was well diversified.

We started 28% in North America, 42% in Europe, and 30% in Asia.

Every quarter since I've been with ProLogis and reported on our investment activity, I've been describing record performance, and this call is no exception.

We now have an impressive record CDFS pipeline of more than $5.3 billion of properties that were 52% leased at year-end.

This compares favorably to the same time last year when our pipeline was $3.3 billion and 47.5% leased.

Over the last 12 months, we have increased our CDFS pipeline by 60%, and at the same time increased the percentage leased.

Our completed developments and repositioned assets of $3.1 billion are on average over 72% leased, which supports a steady source of future CDFS income.

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

This geographic diversification is also critical in mitigating risk.

Our development guidance of $3 billion to $3.3 billion in starts for 2007 may sound like a large amount, but when looking at our global opportunities and the expected mix of starts being fairly evenly distributed throughout the world, we are very comfortable with the ability of our global development teams to execute at this level.

Looking at fourth quarter development activity in North America, we began new projects in Mexico City and Guadalajara.

We entered these markets last summer through a strategic acquisition that included 140 acres of land to support up to 2.9 million square feet of additional development.

We also began new construction in Washington, D.C. and Toronto, where spec development remains limited and it is increasingly difficult to acquire land.

In Europe, we started two facilities in Madrid and two in the Netherlands, where demand appears to be increasing.

We also began construction of a build-to-suits for Carlsberg in southern Poland, and for Homebase, a do-it-yourself retailer in the Midlands.

In Japan, we began two new facilities in Tokyo, and in China we started development of four buildings at our new park in Minhang, which is located in the central part of Shanghai.

We also broke ground on four buildings at ProLogis Park Sanshan, located outside Guangzhou, and adjacent to the river port complex.

These developments bring total starts in China for the year to approximately $100 million, or roughly 2.9 million square feet.

Given our global opportunities and our development start objectives, continually replenishing our land bank is a key priority.

In support of that, we acquired two sites in southern California during the quarter, and an additional 80 acres in Mexico City, that we expect will double starts in 2007.

In Japan, we we acquires three key sites in Tokyo that will support approximately 400 million in new starts.

We also invested in additional land in China within the cities of [Qingdao and Hangzhou].

In Europe, we significant expanded our land bank in the UK with the Severn Trent transaction, which will support development of up to 3.5 million square feet in the Midlands.

You should expect to see land held on our balance sheet rise ratably with the increase in our development activity.

In general, we plan to maintain a land balance on average that will support about two years of development.

Looking at our mixed use business, as projects like L.A.

Air Force Base are completed, we expect to backfill the pipeline with new projects.

During the quarter, we announced that we received approval for a new project in Alameda, California.

The Alameda Landing project will developed on an 81 acre waterfront site that was formerly a U.S.

Navy industrial supply depot.

When completed, it will include up to 300,000 square feet of new retail development, 400,000 square feet of offices, and 300 single family homes and townhomes.

We will receive title to the land and fund approximately $100 million in planning, clean up, and public infrastructure costs.

We will recoup a portion of that through tax increment bonds and other public funds over time, and expect value creation through both vertical development and the sale of improved land.

Our Catellus division has a strong reputation for these types of projects, and we will continue to pursue opportunities such as this and retail warehousing in key markets.

In summary, we are very excited about the acceleration in our development business, and look forward to capitalizing on the many opportunities we have around the global.

And now I'll turn it over to Dessa.

Thanks, Ted.

For the fourth quarter, we reported $1.11 of FFO per share and $1.28 of earnings per share.

Fourth quarter results were driven by the recognition of the $109 million promote, related to the PEPR IPO that we discussed last quarter.

For the full year, we grew FFO per share by 36.5% to $3.70, which included $0.03 per share for our portion of PEPR IPO-related costs.

Earnings per share for 2006 were up 89% to $3.32, driven by substantial non-core, non-CDFS disposition activity during the year.

I'd first like to touch on the performance of each of our business segments and the business drivers that we watch relative to our guidance, and then cover some of our assumptions for 2007.

Beginning with property operations, last quarter we increased our expectation for same-store NOI growth to 2% to 3% for the year.

We are happy to report that we achieved NOI growth of 3.1%, slightly above that range.

Customer retention was 76% for the year, coming in ahead of our guidance of 60% to 70%.

Leasing in our stabilized pool was up 58 basis points for the third quarter, resulting in year-end occupancy of 95.3%.

We began 2006 at 94.5% leased, and previously indicated that we expected occupancy gains to moderate and settle in around 95%.

That is just what we are seeing.

As Walt noted, we are finally capturing rental rate increases in our numbers.

Steady improvement over the past year culminated in rent growth of 5.6% in the fourth quarter.

In every key property operations measure, we met or exceeded our guidance.

Turning now to development proceeds and gains relative to expectations, CDFS dispositions of $1.6 billion year-to-date were slightly below our range of $1.7 billion to $1.8 billion.

Total dispositions and contributions, however, were $2.3 billion, as we also generated more than $725 million from non-core, non-CDFS dispositions.

We expect to continue to generate proceeds and earnings from the active management of our portfolio, as we dispose of certain assets from markets with less rental growth potential, and redeploy the proceeds into markets with better rent growth prospects.

A portion of the non-CDFS dispositions were non-industrial assets that we identified as part of the Catellus merger.

Importantly, over 90% of those proceeds were redeployed into markets, such as New Jersey, Southern California, and Chicago.

Consistent with the NAREIT definition of FFO, the $185 million of gains we recognized in 2006 from these transactions was not included in our FFO.

Profitability in our CDFS business continued to be strong, with average post-tax, post-deferral margins of 24.3% for the year, or $327 million of gains, just ahead of our guidance of roughly $300 million to $325 million.

Fees from our property funds of $212 million were slightly ahead of our guidance of $205 million to $210 million, which included promotes related to the liquidation of North America Funds II, III, and IV and the PEPR IPO.

Including these transactions, FFO from our share of Fund income of $128 million was also in line with guidance.

Our guidance for other CDFS income, which consists of development and management fees, income from CDFS JVs, and interest on long-term notes receivable, was between $90 million and $110 million.

These three line items totaled $112 million for 2006.

On the expense side, G&A was above our annual guidance for 2006, as we continued to invest in the growth of our business and expansion into new international markets.

G&A also includes the $5 million contribution that Jeff mentioned to the ProLogis foundation.

Net interest expense and preferred dividends were right in line with expectations of $300 million to $330 million.

Our balance sheet remains strong, with total debt to book capital of about 55%, and 39% on a market capitalization basis.

Our percentage of floating rate debt declined to 30%, which is consistent with our long-term expectations.

Finally, turning to our guidance for 2007, we expect property operations to remain strong, with same-store NOI in the range of 2% to 3%, reflecting stable occupancies in the mid-90s, and stronger positive and -- and strong positive rental rate growth.

In our development business, we ended 2006 with a well-leased CDFS pipeline of over $5.3 billion.

The pipeline today has approximately $3.1 billion of completed and repositioned assets that are 72% leased, and will be ready for contribution.

We expect CDFS post-tax post-deferral margins to remain consistent with 2006 levels, in the low to mid 20% range.

Given our excellent visibility into embedded gains within our record $5.3 billion CDFS pipeline, we are confident in our ability to continue to grow future CDFS profits beyond expected 2007 levels.

At the same time, strong contributions in 2007 will support growth in both property fund fees and income of roughly 25% to 30%.

Notably, this guidance does not include the recognition of any promotes or incentive returns.

As some of our strategic investments roll off and we invest in new projects, we expect that other CDFS income, including development management and CDFS JV income, will decline in 2007 to between $60 million to $65 million due to the irregular timing of these projects.

In addition, interest on long-term notes receivable will be approximately $12 million in 2007.

While we expect this income to moderate as noted previously, our mixed use business revenues will be lumpy, but they will grow over time.

Finally, having invested in people and systems over the past couple of years, we expect the rate of growth in G&A to dramatically slow to about 3% to 5% increase over 2006 levels.

We believe that our expense structure is well-balanced to allow us to grow FFO significantly in 2007 and beyond.

Thank you.

We look forward to an excellent 2007 and sharing our results again with you next quarter.

Operator, we are ready to take questions.

[OPERATOR INSTRUCTIONS] Michael Bilerman, Citigroup.

Jon Litt is on the phone with me, as well.

I'm not sure who can take this, but thinking about the development pipeline and the visibility into '07, can you talk a little bit more broadly as you look out to 2008 and 2009 as you have so much built up ready to contribute, what the margins look like in '08 and '09?

Yes, this is Ted Antenucci.

Right now our CDFS pipeline, the margins in the current pipeline are consistent with our margins last year.

And going forward, we continue to think that cap rate compression is going to decline, but it's continuing to occur throughout different parts of the world.

And although we will plan for cap rate compression to stop, and margins to slowly come down, right now, our margins are strong, and our visibility is that we will maintain the margins that we got last year, maybe a little bit lower this year.

And in the future, we've always said the business is somewhere in the high teens, and we think future profits will be consistent with that.

Jay Habermann, Goldman Sachs.

Just following-up on that question.

Could you comment a bit more on the land costs?

Where they are now as a percentage of sort of a total development cost, and sort of the projected increases you're seeing as you look out over the next year or so, in terms of land, as well as building costs?

Ted, why don't you answer that on North America.

Then you and I can do Europe together, and I will talk a little bit about Asia.

In North America, cap rate compression really has done two things.

It has brought lease rates down and simultaneously land values up.

The lease rates -- the decline in lease rates has pretty much ceased in almost every market.

And land values have gone up enough and construction costs have gone up enough to surpass the savings in cap rate compression.

So overall, land values are up in the U.S., and right now are continuing to grow.

Certain markets, like Southern California, they're growing significantly.

In Europe we're seeing in the significantly supply constrained markets, i.e., in the UK, a market increase in land values over the last 24 months, commensurate with strength in demand -- customer demand, as well as the decline in cap rates, or compression in cap rates.

Although, we have not seen compression in cap rates in the UK, same order of magnitude that we've seen elsewhere in the world.

In fact, we've talked internally where the UK has seen cap rate compression order of magnitude 100, 125 basis points over the last three to four years.

That compares to places like central Europe, where you've seen 300, 400 basis points of cap rate compression.

U.S., where you've seen 200 to 300 basis points.

Japan, where you've seen at least 200 basis points.

China, probably 200 basis points.

On a relative basis, we see some of the best values in the world being in the UK today, given the strength of the covenants, given the strength of the lease structures, and the shortage of space there.

Central Europe, you've seen land prices increase on the continent increase, given the shortage -- lack of available development land and strength of the markets.

In Japan, where, when we started the business there in 2002, we were in a market that had seen from the peak of the bubble, or bursting of the bubble in 1990, land prices decrease approximately 65% to 70%.

Over that 12 year time period, we've now seen increases in land values on the industrial side, as well as in the office, retail, residential side.

So you're seeing a very strong market there.

And in China, quite frankly, with rental rates increasing at 8% to 10% or more rate-type trending, we're seeing increases in land values there.

And the value of the pipeline we've put together, the options we've put together over the last 36 months, are proving to be just incredible on a go-forward basis.

The other part of your question was land value under building.

And that varies greatly depending on what market you're in.

There really is no consistent number that you could use as a percentage of total costs.

But overall, whatever land costs are, in just about every market but Japan, you can -- you're going to assume you're going to get about 40% to 45% coverage.

And that would give you an idea of how much the land is underneath the building.

James Feldman, UBS.

You've clearly stated that demand remains strong across your markets.

Could you address the state of expected new supply and address those markets which cause you the most concern?

And also talk about whether the rising land prices you just talked about are acting as a material governor on new construction at this point in the cycle?

And then finally, you said rent growth should be strong.

Can you give us a little more indication in terms of percentage basis how strong rent spreads can be?

James, this is Walt.

It's kind of interesting that if you looked at the net absorption in the U.S. markets, and the U.S. markets are probably best tracked, we had positive absorption in every single one of the 30 markets last year.

In no market did we have supply in excess of demand.

So overall, as I mentioned, you had 149 million square feet of demand.

And you had 135ish million square feet, if you will, of deliveries.

And so really, it's in balance.

Interestingly enough, none of the markets were out of balance.

So I don't think we have a market that we're "concerned" about today.

There's no question that, and I think it's been well documented, that Southern California has been a very, very strong market.

But I don't think we could say that there's any markets that are really weak today.

And in terms of land prices rising as a governor, I think both land prices and construction prices that are up materially, needless to say, over the last three years, and I mentioned in my remarks 30% to 50%, I think have been a very strong governor.

Because yes, we are beginning to see rental growth.

But rental growth did not keep pace with the rising construction costs and the rising land prices, and I think it kept a lot of people on the sideline.

I also do believe overall in the product type, because the product type is one that you develop within a six to seven month period of time in most markets.

The tap does tend to get shut off, and there does tend to be some discipline overall in the industrial arena.

But having said that, there's no question that rising prices have choked off supply.

It's been a good thing.

And I don't remember the third question, I couldn't write it down fast enough.

I think you hit it, inadvertently, through everything else, you hit it.

Lou Taylor, Deutsche Bank.

Dessa, it looks like in your foreign exchange line item, you've got a little bit more sensitivity to changes in the dollar in '07.

Are you guys modifying your hedging strategy at all?

Or is that just growth in overall exposure to currencies other than the dollar?

We haven't modified our foreign exchange hedging policy.

But there's about $0.02 or so, $0.01 to $0.02 of FX movement.

And it really just comes from the normal movement of, either hedging transactions that we see are coming, that we know are going to be contributing transactions or contributing assets.

For the most part, it has been pretty mild, so we haven't changed it.

Our focus obviously continues to increase in Europe and in Japan.

So more of our earnings are coming from that area.

So we continue to try to protect on the downside.

But the -- there will be some noise in the foreign exchange going forward, because we're a global company and we expect to have both -- we expect to have the positives from that and to protect you on the downside.

Chris Haley, Wachovia.

It's Brendan Maiorana with Chris.

Walt, you mentioned that replacement costs are up 30% to 50% over the past couple of year.

What do you think has been the increase in rental rate growth over that same time period?

And looking back historically, what do you think the relationship has been between increases in replacement costs and changes in rents?

That's a great question.

I wish I had the exact answer to that, but -- on the second part.

But the first part, that's the thing that's encouraging to us looking forward, and has been relatively discouraging looking back on the rental rate side.

There's no question, if you look in the U.S., really in the last three or four years, rents have been down, even though replacement costs have gone up.

We're beginning to see increases today up.

Supposedly asking rents for the fourth quarter were up 7.6%, I believe, vis-a-vis asking rents in the third quarter.

So you can begin to see where asking rents are going.

You can look at where ProLogis was at 5.6% rental growth for the quarter.

And so needless to say, rents are now beginning to rise.

They're nowhere near the replacement cost rise, but that's been offset by the cap rate declines of roughly 30% to 40% in all of our markets.

You're seeing that pretty much everywhere in the world.

Where we're beginning to see rents begin to climb is in a lot of our U.S. markets, definitely in the UK.

I'd say rents have been relatively flat in Europe over the last year, and probably down in the last two to three years before that, again, because of cap rate compression.

And rents are rising, as Jeff mentioned before, in China.

So overall, we've been in an environment where we've had flat to declining rents in the last two to three years.

We don't see any more of that in practically any of our markets today.

We think rents will rise.

But I think a lot of that depends on where cap rates are going to go in the short run,and what's going to happen with replacement costs in the long run.

And I don't really have a great correlation.

But I've got to believe over time that they correlate fairly closely.

Absolutely.

Paul Morgan, FBR.

Regarding Asia, a couple things.

Could you first maybe comment on the tax performance in China, whether you expect that to be any impact on the type of tenant demand regarding specific zones in China?

And then second, any progress in India?

Paul, it's Jeff.

Let me first comment on the unified tax which has been enacted in China.

It does not impact our operations in that we have never structured anything with favorable or special tax treaties, or special tax treatment in any of the projects we've done in China, nor have we ever underwritten for those.

As it relates to potentially impacting customer demand or the amount of manufacturing activity taking place in China, clearly the Chinese government wouldn't move to a unified tax system and eliminate these special grants that were given.

And it's actually was municipalities competing against each other for the same manufacturers.

So in my opinion and the opinion of our team there, it will not decrease the amount of total foreign direct investment.

It just eliminates an inefficiency of the market of a Suzhou competing against a [Tanjen] for the same potential manufacturer, and giving away something that they didn't need to give away to induce people to manufacture in China, given both the growth of China, the cost advantages of being in China, and most importantly long-term, the internal market opportunities in China, which are massive and which we're just starting to see the impact of.

As it relates to India, it's early days there.

We've got a team on the ground, a very, very talented team, one that we're excited about.

None of the numbers that Dessa went through, that Ted went through, that Walt talked about, include anything for India.

Anything we do in India is upside, is incremental growth beyond what we've talked about.

We're not going to put pressure on the team there.

No different than we didn't put pressure on our team in China early on.

Nor did we put pressure on our team in Japan.

We want to grow the business the appropriate way, take a market leadership position over time.

And whether that takes 12 months, 24 months, 36 months, or 48 months is irrelevant.

We're in this business for the long-term to build a long-term great Company, and we'll build a long-term great franchise, we hope, in India.

Ross Nussbaum, Banc of America Securities.

Dessa, I've got a question on the income tax line.

Looks like you're forecasting it to be flat in 2007.

Can you just remind us what the primary driver is, and why is it going to be flat if profitability is up?

Yes, the income tax is driven somewhat by our contributions out of Europe, in the UK, especially.

It's netted against -- you can net some of that portion against CDFS.

It also is driven by some of the earnings in the development management and other income.

So with those two line items, we actually have taxable income that shows up in the tax line.

Last year's had a significant amount of about $27 million that had to do with L.A.

Air Force Base in it.

And we'll continue to see some taxes from those type of developments.

Christopher Pike, Merrill Lynch.

Jeff, pretty well-covered call here.

So let me ask you this.

Given how well you and your team are executing globally and domestically, operationally, as well as in the fund business, is there anything at this point that does give you modest pause, whether it's maybe the lumpiness of the mixed use business or some other facet of what you guys are doing?

The lumpiness -- Chris, the lumpiness of the mixed use business doesn't give us any pause long-term.

We're in the business for value creation -- shareholder value creation.

And the ability to create hundreds of millions of dollar in value in one project, whether it be the Austin Airport redevelopment, the Miller Airport in Austin, or whether it be Alameda, whether it be any of the projects, major projects, that are complicated, they're sophisticated, they take a lot of time, they take a lot of effort, they take very strong teams, which we were very fortunate to inherit as part of our Catellus merger, that are executing extremely well, that doesn't bother us.

We can plan for that, we understand that, we project for that.

What does -- and people always ask, with the business operating so well around the world with such a great team in place, great customer relationships, what are you worried about?

I worry about geopolitical risks.

I worry about things that -- some of these things are outside of our control.

The things that we worry about within our control is making sure that we continue to strengthen our customer relationships, that we continue to strengthen our land positions, that we don't take for granted the market positions we've created around the world, and that we maximize on the opportunities in front of us.

And that's what we wake up and do every day.

David Harris, Lehman Brothers.

I think this is a question for Ted.

In the notes to the '07 guidance, you reference your development activities being more focused towards Europe.

And if I look at GDP forecasts for Euro zone, the forecast for '07 and '08 is substantially below the growth we're expecting out of the U.S. or Japan.

And obviously, I'm sure you're aware that we're looking at political change in France, and change of premiership in the UK, which may cause demand to interrupt there.

I just wondered if you could just rationalize why you're looking to ramp up development in Europe given those circumstances?

I think we're all -- David, this is Ted.

We'll all probably chime in on this.

But where we're seeing a significant increase in starts right now is in central Europe, where there's tremendous growth.

I don't know if you've had the opportunity to go out there, but it is amazing what's going on as those countries expand and grow, and start to integrate with the balance of Europe.

We're just in phenomenal demand in those markets from our global customers, a lot of which are logistics providers, who are moving product for major companies throughout the world.

I think UK is so land constrained, and the sites that we control and are developing are so unique that we're seeing demand for product in those locations.

I think we are focused on France and Italy, and some of the things that are going on there.

We are seeing, frankly, not great demand in Italy.

I think in France we're seeing demand that's been consistent with what we've seen in the past.

And we continually monitor that.

But right now, I think the big growth for us is in central Europe.

David, this is Walt.

Let me just add that really, if you look at our business in the last five to seven years throughout the world, GDP growth is important, no question about it.

But in places like Europe, where there's just a massive restructuring of the overall supply chain, that's continued to drive our business year-in and year-out.

And so while we watch GDP, and GDP is definitely important, it is not the single most driver in Europe, as I think it is in, more so, at least in the United States.

And then back to Ted's point on central Europe.

You look at it a year ago, we weren't in Romania.

Today we are.

We did our first lease in Romania earlier in the year.

We were in four cities in Poland, and Jeff said that now we're in seven or eight cities in Poland.

Czech Republic, Hungary, these are all markets that we were just really penetrating a year or two ago, and now we're increasing market share.

We're increasing the submarkets that we're in.

And you compare and contrast that to again, let's say in the U.S., where we are basically in all the submarkets that we want to be in today.

And it's really just increasing market share.

So I think a lot of it is growing into new markets, as Ted said, and a lot of it is just the overall restructuring of the supply chain in Europe.

Those two things are driving it pretty well.

Let me -- this is Dessa, just add one other thing.

The comment was meant also not about necessarily the strength of Europe, but if you look at our development last year, we had over 40% in Europe also.

So it's consistent with where we have a great market positions, and there are a number of markets in Europe that we can develop in.

I think everyone -- I don't want to continue this, because everyone has made some great points and absolutely correct.

But if you look at the growth we had in Japan between 2002 and 2005, where you actually had negative GDP growth, yet we built both a market leadership position, a very profitable position and created a lot of shareholder value during a period where there was negative GDP growth, it is because of excellent execution in our teams, market leadership positions, and land constraint markets mean a whole lot.

GDP growth in Houston is very -- I would rather have 2% GDP growth in a land constrained market, than 4% GDP growth in a non-land constrained market, like a Dallas or Houston, where you're not going to see that much rental rate growth either way.

Land constraint does a lot for growth.

And to tease you a little bit, David, I don't understand why you're worried about an unpopular labor government being potentially succeeded by a either a pro-business conservative or a very conservative new leader of the labor movement.

So either way, we see that as a positive going forward in the UK business.

Matt Ostrower, Morgan Stanley.

Just on CDFS, it looks like your completed projects in Asia surged and they were very well leased.

Just in terms of thinking about the progression of CDFS throughout the year, would that suggest like sort of higher margins or bigger volumes, even potentially, in the first quarter of the year?

Probably within the first half of the year, I would say that the CDFS from Asia, they are well leased and in good shape, and we do expect strong margins out of Asia this year.

David Fick, Stifel Nicolaus.

Dessa, can you tell us what assumptions you're making about forward interest rates, both in the U.S. and the UK?

And then can you also comment on your retail development focus?

You've got $96 million right now.

Is this going to grow over time?

Well, on the interest rates, we look at our interest rates kind of on a portfolio basis.

And right now we are seeing relatively stable interest rates.

I would say we're kind of seeing -- our marginal cost is probably 25 to 50 basis points up.

But that doesn't affect our overall portfolio debt by more than, say, 5 to 10 basis points over the next year or two, depending on how much more debt we end up, how much we grow.

But that's the way we're thinking of it.

We are not seeing -- our expectation is not for huge hikes in the long-term.

But like I said, marginally, maybe a 25 basis point increase on a marginal debt basis.

As far as the retail development, I think you're talking about the other development in income.

What we've guided down to is kind of 60 million to 65 million in that line, and I'll let Ted talk about what's happening in that area.

And it was L.A.

Air Force that brought it up so high.

So go ahead.

David, this falls into the category of the lumpiness of the mixed use business.

And Dessa was referencing that L.A.

Air Force Base was a line item last year.

We do have several significant retail warehouse projects going on.

One is in Austin, a phenomenal location right off the highway, substantially leased.

Actually right now, we're working on a lease with one of our global customers.

We're finding a significant level of synergy with our customers in the retail warehousing that we're developing.

We also are doing a project in Pacific Commons, which is in Northern California in Fremont, that is also just being completed, is 95% leased.

We have a couple small units left, that is under development.

And then we just got our entitlements in Alameda.

So it's an area that we continue to focus on.

We like the product, we like the synergies with our customers.

We're, for the most part, breaking ground on projects that are substantially preleased with, really with global customers.

So we're going to continue to grow that.

It's is the same -- and we love it, because it's the same customers, David.

Whether it's Home Depot, whether it's Target, whether it's Wal-Mart,Bed Bath & Beyond, Circuit City, Best Buy.

They're all people that we're serving their distribution requirements currently, have strong relationships with them, same basic construction.

A little better location, which there's nothing wrong with owning great locations, and very strategic, irreplaceable locations, and the value creation is significant.

David, this is Walt.

One other thing -- well, really two points.

We also have a project in the UK at Dartford east of London, which over the next three to four years will contribute substantially as well to profits.

And interestingly enough, if you look at between -- Ted talked about Austin Miller Airport, you talk about Alameda Landing, you talk about Dartford, these are all projects that we don't have a substantial amount of capital on our balance sheet today.

But yet will contribute, we think, significant profits in the future.

And we'll talk about more about that in the future.

Michael Mueller, JPMorgan.

I was wondering if you could talk about earnings mix for a moment?

Specifically, gains as a percent of FFO.

Looks like it's now in the mid-50s based on the '07 guidance.

Does this percentage plateau around here?

Or should we continue to expect it to rise?

Well, I -- from an earnings mix perspective, it is around 50%, 55% this year of FFO.

But what I would say is, it could continue to grow.

But the reality is that the growth will come more from the fund management and fund income.

So if you think of that area growing, it's kind of 25% to 30% at this level, and the CDFS profits could grow 5%, 10%.

The mix is going to start changing slightly to be higher towards the fund management, fund income, development management, development income.

So I would say it's not a bad thought to think of 50%, 55% being kind of probably a high end of where CDFS would be as a percentage of total FFO.

But it really depends on the margins we're seeing, and it depends on the opportunities we see over the next few years.

The beauty of what we've, Michael, what we've built, and what we continue to build is the CDFS business.

The development business drives our fund management business, which becomes an annuity in the form of asset management fees, long-term in the form of incentive fees/promotes.

And that's a continued business.

And as the years go by, we see that becoming a larger and larger percentage of our business, which we're real excited about.

Cedrik Lachance, Green Street Advisors.

Jeff, you're now invested in pretty much all of the large developed economies of the world.

As you think about expanding to new countries, how do you assess some of the political risk?

You touched a little bit on geopolitical risks earlier.

How do you assess that?

How do you assess the kind of return hurdles that you need to get?

And how do you think about further expansion in some countries, such as eastern Europe, where you still have a certain amount of risk involved that is not in other countries where you invest, such as western Europe or the U.S.?

Cedrik, that is a very, very good question.

And something that I would love to spend a couple hours talking to you about, because it's something that I think about all the time.

And I can not do it justice in two minutes, I'll try.

But one, in my initial comments, I know I went through those very fast, I noted that the countries that we operate in today, and this is ex-India, or excluding India, represent 76% of the world's GDP.

So -- and if you look at, while we may have market leading positions, our overall percentage of assets owned in any of these countries is relatively small.

Probably the largest might be the U.S., and that's still well below 6% of the competitive stock in the U.S.

So there's a lot of room to grow in the countries we're in today.

We don't see a reason to take major geopolitical risk, given the fact that the countries we're already in represent 76% of the world's economy.

The rest -- everything else is relatively small, particularly on a percentage basis, relative to where we are today.

We're in the best countries today.

We don't see a reason for any major geographic expansion beyond the places we do business today.

We'd rather focus those places, increase our market share, increase our penetration both with customers, with competitive positions in those markets.

We see it as being a more conservative way to grow the business, and quite frankly, a more effective way to grow the business.

Then you throw in the other factor, that I think there's been such a massive re-weighting or under-weighting of geopolitical risk from a yield standpoint.

If you look at Russia, in 1997 we turned -- I turned down, personally, deals in Russia at 30% yields.

I'm not certain that there's less geopolitical risk in Russia today than there was in 1997.

Clearly, there's a stronger economy.

But that's driven by oil prices, commodity prices.

Yet today people are doing industrial deals at 9% yields.

We don't see a reason to invest our own capital directly in that kind of environment.

Nor do we see a reason to go into a lot of the other eastern European countries.

Countries in Asia, if you look at Asia as a whole, Japan represents a bigger economy than the rest of Asia combined.

China has a larger population than the rest of Asia combined, and is growing obviously faster.

So why divert our attention to other countries, with the exception of South Korea, which happens to be in the middle of the two of them, and a natural trade partner and easy for us to execute in.

That was a long way of saying, if your question was, how much geographic expansion do we expect to have over the next couple of years?

With the exception of India, which we see as a significant opportunity, but we'll take our time there and we won't take undue risk, we don't see a lot of geographic expansion.

We think we're in the right markets today, we're going to focus on that.

We want Walt spending his time, we want Ted spending his time, we want our team focused on the places that we can add the most value and those are the places we are today.

I think, operator, we have time for one more question.

Steve Sakwa, Merrill Lynch.

I know you guys have a very large and growing development pipeline.

But you also bought about $1.1 billion of assets, some -- most of it is on balance sheet and some in the funds.

Can you just talk about what were the rationale?

Were those to get at land banks, were those value-add opportunities?

I guess, what do you see in the market today with regard to acquisitions?

And then Jeff, if you could just maybe go through some of the markets globally and give us an idea where cap rates are, that would be appreciated.

Between Walt and Ted, we can talk about our acquisitions.

A lot of that was driven by 1031 requirements.

Yes, Steve.

As part of the Catellus merger, ProLogis ended up with a lot of nonindustrial properties.

And for the most part, the decision was made to -- office buildings, hotels.

And the decision was made to sell those properties.

Because of Catellus' retransition in the early 90s, there was still a C-Corp tax that would have been paid had we just sold those assets.

So we 1031'd out of what we would term as non-core assets into industrial assets.

And that's the majority of those transactions.

Clearly, some were repositioned assets, and some were assets that we thought would fit well with our current assets that are wholly owned.

So it's a little bit of a mix.

But the majority was driven by the 1031s, which was part of the Catellus merger.

And, Steve, I believe it was on the last call, we did mention that -- it was kind of interesting, when we went into the Catellus merger, we -- Jeff and I really believed that we'd have about 100 basis points of total dilution associated with selling the office and the hotel, and putting it back into industrial.

Interestingly enough, our dilution has been less than 25 basis points.

We've been at an extraordinary time to sell off the assets that we saw as non-core.

And we're good enough in our markets where we were able to pick off some acquisitions that we could -- that perhaps others couldn't.

And we were able to reduce the dilution overall associated with that.

It was like $750 million to $800 million in dispositions.

So it was a big number.

What percentage was invested in very strategic markets, like California, New Jersey, Chicago?

Over 80%.

Dessa didn't throw out the percentage, but over 80% of the redeployment was either Southern California, New Jersey, or Chicago.

So we're real happy with what we ended up with.

With very minimal dilution.

Steve, and we'll have to wrap it up after this.

But to answer your question on cap rates around the world, kind of do a quick global tour.

Starting in the U.S., we're now seeing cap rates -- we'll just talk about Class A, because obviously there's quality differentials if you're talking about B or C assets.

We don't own any C assets, but we'll just talk about pure A assets, which is by far the majority of our assets on a global basis.

Really looking low 7s in the U.S. to a 5, or just slightly under 5, and the lowest cap rates in the U.S. would be in Southern California, and the only times we really see those dipping below 5 is where you have rents below market today.

So at-market rents, we're really seeing kind of 7.25% to 5% depending on the market in the U.S.

Moving to Europe very quickly, we're seeing cap rates in central Europe move to the 6.5%-type range.

People expect significant continued growth in demand, and going forward, rental rate growth after this massive cap rate compression that's taken place in central Europe.

And when I say central Europe, to Cedrik's last comment, I'm really talking about Poland, Czech, and Hungary only.

I'm talking about the big three that were the initial entrants into the EU and into NATO, that are the most stable and the most integrated into western Europe.

In western Europe itself, we're seeing all cap rates below 7%, 7.25% being kind of at the top of the range for Class A product range, ranging down to the UK.

And quite frankly, again, we see the UK being some of the greatest values in the world, given our expectation for rental growth there, given the lease structures, which are 15, 20 year FRI leases.

True, true net leases, with upward-only rent reviews to market every five years, and those are in the 5% to 6% type range.

We see those being tremendous values on a -- by today's standards.

In China, surprisingly for us, we've seen -- and this is a lot of value creation.

It's a good surprise, very positive surprise for our shareholders.

We've seen current cap rates ranging down to 6.5%, because everyone expects, and have seen significant rental rate growth, significant appreciation in land.

Land is appreciating order of magnitude 30% a year over the last three or four year.

Rental rates are going up at double-digit rates, so you're seeing cap rates very low.

So we've created a lot of value in our developments there to date, and clearly in our land pipeline and land bank, both options and land that we own today.

We're taking down more land there to secure our positions.

In Japan, where we started there in 2002 and we had cap rates ranging lowest 6.25%, ranging up to 8%.

The market now understands how dynamic, how land constrained that market is, and we're seeing cap rates probably down 200 basis points from that point.

Kind of 4.25% at the low end to 5.5% on the top end there.

But very, very positive financing opportunities.

I know that was quick.

But that kind of took you around the world to the major markets we're in today.

Very significant activity in all of them.

Just kind of wrap it up, thank everyone for their time this morning.

We're looking forward to seeing a lot of you in Naples in a few weeks for the conference there.

And thank you again, and we'll see you all soon.

Thank you for your participation.

That does conclude today's conference.

You may disconnect at this time.