Prologis Inc (PLD) 2014 Q2 法說會逐字稿

Good morning. My name is Steve and I will be your conference operator today. At this time, I would like to welcome everyone to the Prologis second quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.

(Operator Instructions)

Thank you. Senior Vice President of Investor Relations, Tracy Ward, you may begin your conference.

Thanks, Steve, and good morning, everyone. Welcome to our second quarter earnings conference call. The supplemental document is available on our website at Prologis.com under Investor Relations.

This morning, we'll hear from Hamid Moghadam, our Chairman and CEO, who will comment on the Company's strategy and the market environment and then from Tom Olinger, our CFO, who will cover results and guidance. Also joining us for today's call are Gary Anderson, Mike Curless, Ed Nekritz, Gene Reilly, and Diana Scott.

Before we begin our prepared remarks, I'd like to state this 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 or SEC filings.

Additionally, our second quarter results press release and supplemental do contain financial measures such as FFO and EBITDA that are non-GAAP measures and in accordance with Reg G we have provided a reconciliation to those measures. With that, I'll turn the call over to Hamid and we'll get started.

Thanks, Tracy, and good morning, everyone. The second quarter was one of the best we've had in recent memory. Each of the three business lines contributed to our strong performance. With our portfolio repositioning now substantially behind us, our investment strategy is even more focused than before. We operate only in the best markets serving global trade and regional distribution.

The benefits of this strategy were evident in the following operating metrics. Our same-store NOI growth reached its highest level since the downturn. We've had six consecutive quarters of positive rent growth on rollover. Small unit leasing is up in the US, and we're seeing a surge in our value-added conversion business. On the capital deployment front we started new developments with higher than average margins. We have a growing pipeline of opportunities and a land bank well positioned to serve the needs of our customers.

Turning to capital flows, we continue to see strong institutional interest for industrial real estate. As a result, cap rates continue to compress as evidenced in recent portfolio transactions. The impact of declining cap rates on our NAV is significant. In fact, we've seen cap rates compress about 25 basis points since our investor forum last September. This translates to more than $2 per share of NAV.

The improving markets are also having a positive impact on our value-added conversion activity. This business is unique to several of our key markets that are subject to strong urbanization pressure. We believe our value-added conversion business is poised to produce meaningful gains and NAV appreciation as we convert some of our industrial properties to higher and better uses, particularly in the San Francisco Bay Area which is benefiting from rapid growth of the technology sector. Now, let's turn to our co-investment activity which is hitting on all cylinders.

During the quarter, we recognized a significant promote for USLF and we completed our IPO in Mexico. FIBRA simplifies our structure and positions us for long-term growth for this important region. With this offering, perpetual life vehicles now account for about 95% of our third party assets under management. We also expanded our relationship with our partner in China and raised new capital for our open ended funds in the US and Europe. As our capital activity now includes both public and private sources, on a go-forward basis we'll refer to this business as strategic capital to better describe the focus of these investment vehicles on specific segments of our business.

Let me conclude my comments with a few observations on the current market conditions. In the US, we see our customers being more decisive and proactive to commit to space in anticipation of growth, really for the first time since the global financial crisis. This demand stems from growing inventories, up 5% from last year in real terms and 3% higher than the prior peak. We're in the 17th consecutive quarter of absorption in excess of supply for industrial space. As a result, this excess demand vacancy continues to trend lower and at 6.8% it's now the lowest level in 15 years.

In Europe leasing remains very strong in the UK, Germany, Netherlands, and the Nordic region, while southern Europe and a few markets in central and eastern Europe continue to lag, all our European markets have now turned the corner. In Japan, China, Brazil and Mexico we continue to see excellent leasing momentum. This back drop supports our plans for growth as development markets by and large have remained disciplined around margins and risk levels.

To sum it all up, the second quarter was one of our best ever. As we look forward, we believe the combination of rental growth, the profitable development of our land bank, and the scaling of our platform set us up well for an extended period of above average earnings growth. With that, I'll turn it over to Tom.

Thanks, Hamid. I'll start with our results for the second quarter. Core FFO was $0.48 per share. Quarter-end occupancy was 94.6%, up 90 basis points year-over-year. GAAP rent change on rollover was 6.6% led by the US at 12.1%. Cash rent change on rollover was a positive 0.6%. GAAP same-store NOI increased 3.8% in the quarter, the majority of the increase was driven by occupancy and rent growth.

Looking further into this metric, average occupancy was up 110 basis points versus the prior period while 23% of our leases in the same-store pool rolled over the last four quarters at an average increase of 6%. We did benefit from some non-recurring items, mainly lower expenses, which had a positive impact of about 70 basis points on our same-store results for the quarter. On an adjusted cash basis, same-store NOI grew 5.3%.

Turning to capital deployment. During the quarter we continued to see development margins well above our historical average. Development stabilizations were $371 million with an estimated margin of 23%. We generated $82 million of our share value creation or about $0.16 a share. Development starts were $439 million with an estimated margin of 19%. We invested $412 million in building acquisitions and in our co-investment ventures. Contributions were $26 million and non-strategic building dispositions were $520 million, totaling $546 million or $443 million our share at a weighted average stabilized cap rate of 6.6%.

As Hamid mentioned, we closed our IPO in Mexico this quarter. The formation of FIBRA Prologis was not reflected as a contribution given our underlying ownership interest in those assets remained unchanged. We received equity certificates in exchange for our portion of the Mexican operating assets and hold a 45% ownership stake in FIBRA. This new structure allowed us to reduce the number of ventures in Mexico with a permanent vehicle resulting in a simplified structure and lower G&A.

Moving to strategic capital. Operating income was $48 million in the quarter which includes $25 million of promote income from our targeted US logistics fund. Switching gears to capital markets, we're taking every opportunity to secure long-term capital at today's cost to enhance both the composition of our debt portfolio and liquidity. In the second quarter we completed $3.6 billion of financings. We used a majority of the debt proceeds to retire over $1 billion of secured and unsecured debt in the second quarter and an additional $466 million this month.

The debt retirement was at near zero economic cost on an NPV basis. We now have no meaningful debt maturities until 2017. The cumulative effect of our debt activity over the past 12 months has had a very meaningful impact on our balance sheet. We lowered the interest rate on our bonds by 160 basis points to 4%. We added 3.1 years to the average turnover bond and 2.3 years to the overall debt stack, and shifted US dollar denominated unsecured debt to euro and yen, increasing our US dollar net equity to 85%. We accomplished all of this while building over $3 billion of liquidity.

Let's turn to guidance for 2014. We're narrowing the range for year-end occupancy to be between 95.2% and 95.8% and GAAP same-store NOI growth to between 3.25% and 3.75%. Our net G&A we narrowed the range to between $238 million and $243 million. Looking forward, we believe we can grow AUM with little, if any, incremental G&A. For capital deployment, we're taking our guidance up to reflect the current pipeline of opportunities we're seeing across our geographies.

We're increasing development starts to between $2 billion and $2.3 billion with 85% our share and increasing building acquisitions to $1.3 billion to $1.6 billion with 45% our share. We are lowering contribution guidance to between $1.6 billion and $1.8 billion with 55% our share, primarily due to timing. For dispositions, we're increasing guidance to $1.3 billion to $1.6 billion with 90% our share. From a funding perspective, we have ample liquidity to fund our incremental net deployment.

For strategic capital guidance we're increasing the revenue range to $220 million to $225 million and expenses to $100 million to $105 million generating an operating margin of over 50%. These increases are a result of the higher promote income and fees from FIBRA. I want to point out the strategic capital revenue in the third quarter will decrease due to the impact of the USLF promote in the second quarter. We expect our next promote to be in 2015. For FX, we're maintaining our assumptions for the euro at 1.35 and the yen at 105 for the second half of the year. We expect our US dollar net equity to further improve and reach almost 90% by year end.

Putting this all together, we're exceeding our forecast on all fronts and as a result we're raising our full-year core FFO to a range between $1.82 and $1.86 per share. This represents an increase of $0.05 at the mid point and year-over-year growth in core FFO of 11.5% and translates to full core AFFO growth in the high teens. The recent credit rating upgrades from Moody's and S&P are further affirmation of our earnings trajectory and operational outlook. Importantly, we're well on our way to building one of the strongest balance sheets in the REIT sector.

In closing, we had great results for the second quarter with each of our business lines outperforming. Looking forward, we expect core earnings growth to accelerate as both rents and occupancies continue to increase and to profitably capitalize on deployment opportunities across the globe. With that, I'll turn it over to the operator for questions.

(Operator Instructions)

Your first question comes from the line of Steve Sakwa with ISI Group.

Thanks, good morning out there. I guess kind of a two-parter, but could you just expound a little bit more on the development starts? It seems like the business is very back-end loaded. Sounds like you're pretty confident about that. How should we think about the starts by quarter and then I was just wondering if you could give a little more color on the decline and contributions. And you say it's timing related, Tom, but can you tell us what's going on there?

I'll take the second part of the question first. So, it's just due to timing of contributions, primarily in Europe, that are going to move into the first quarter for a variety of reasons. It has nothing to do with the underlying performance of those assets, it's just the timing of when those assets will move off our balance sheet.

Steve, this is Mike Curless. Relative to the development volume, we had a light first quarter, as expected, and that was due to seasonality and mix primarily; but in the second quarter we had a substantial ramp up and we expect that for the balance of the year. We've increased our guidance range to over $2 billion and we're highly confident in that, when you consider 95% of the remaining work to do is identified, and I contrast that with this time last year we were at 80% on that number.

We think there's bias to the upside on US build-to-suites, some activity in China, and in terms of the complexity or complexion of that work we'll see over the year, 50% should take place in the Americas, 30% in Asia, and call it 20% in Europe, and at the end of the day about 25% in build-to-suites, so we're very comfortable with not only the length of our prospect list but more importantly the strength of that prospect list.

Thank you. Your next question comes from the line of Dave Rodgers with Robert W. Baird.

Yes, good morning out there. Did want to follow up on two things. I guess first talk a little bit about the investment in the NAIF fund in the US. Was that, I guess, in taking out an existing shareholder or was that just net growth capital? Talk about your feeling about putting more money into the US.

We like the values. It's real estate we obviously know really well and I think the ability to deploy capital in proprietary ways in portfolios that we know really well is exactly what we should be doing. We've done it over the years and there was an opportunity to do some more of it this quarter, yes. And by definition, since fund has not been raising new capital for growth, the only way that can take place in that particular fund is to buy out other investors that may want to re-deploy their capital.

Your next question comes from the line of Brendan Maiorana from Wells Fargo Security.

Thanks, good morning. Wondering if you guys could comment on the outlook for occupancy and compare that to what you're trying to do with rent spreads? It looks like the occupancy increase at the mid point of your guidance by year end is up about 100 basis points, but I think the expectation was that rent growth would start to materialize more meaningfully as we move throughout the year. So do you still expect that rent spreads should move higher, even though occupancy it sounds like you expect to be significantly higher by year-end as well?

Yes, Brendan, it's Gene. I'll start with that and Gary can comment on the rest of the geographies, but we do absolutely expect that rent spreads will continue to grow in the Americas, so we're at 11.3 and if you look over the past five quarters we've grown that from 2% or 3% and at a pretty straight line up to that level, so we think that will continue. We think in the US we'll have a chance for somewhat higher occupancies, but frankly we have the teams now really focus on rent growth. So, those are the dynamics that play really throughout the Americas, including Brazil and Mexico, and I'll turn it to Gary.

Yes, so Brendan in Asia, as you know, we've been bouncing around between 95% and 96% and that's right where we want to be. We're pushing rents in both Japan and China and we expect that to continue through the balance of the year. If you look at Europe, we grew occupancies 30 basis points and we would expect to grow occupancies over the course of the year. Europe is a little bit of a mixed bag as we talked about before, as Hamid said on the opener. UK is strong, northern Europe is strong, central and eastern Europe and southern Europe are lagging. So, in terms of rent spreads, we're able to push rents in those two key geographies and the others we're not.

If you look at this quarter in particular, about 75% of our leasing in Europe was in central and eastern Europe and southern Europe, so not an opportunity to push rents there. And as you go forward, at least for the next two quarters, you see sort of about the same trend. So, we're not expecting any real rent growth out of Europe, but we'll be getting it out of the Americas, as Gene mentioned, and out of Asia.

Yes, the only thing I would add to what Gary said in Europe is that cap rates in Europe have compressed a lot faster than we thought when we put together a long-term rent forecast and obviously declining cap rates are a head wind for rent growth. So, I would say rent growth in Europe is probably delayed by some period, maybe six months, maybe a year. But, boy, cap rates have come in over 100 basis points in most of the continental markets, so I think its impact on NAV would be very positive.

And, Brendan, just one other thing is Hamid pointed out at the beginning of the call, we think all of the markets in Europe have bottomed and have turned in the right direction and I think Europe will actually be a tail wind for us going into and through 2015.

Your next question comes from the line of Michael Bilerman from Citi.

Yes, good morning out there. So, I had a question in terms of the North American fund buy-in. If you take your $275 million of equity growth set up for the 19% stake and add in the debt you get to a gross book value just under $2.6 billion which would be about a 6.5 effective cap rate on that capital that you put in. So, one, I just wanted to understand how does that 6.5% compare to what the NAV of the fund is in terms of this proprietary book you talk about? My sense is it would be lower but I wanted to sort of get your view, number one. And, number two, how does that $275 million of equity, $480 gross in terms of the assumption at debt, factor into the capital deployment on Slide 8? Is that in there or not? Thank you.

I'll let Tom answer the latter part of your question, but your math is pretty close. It's in that range plus or minus 10 basis points. We acquired it at stated NAV, which is determined by third-party appraisers on a regular basis, but we see value in that NAV. As you know, appraisals can lag, they can lead, but we know the portfolio well.

You've got to know what the mix of the assets is, which you don't, as well as we do and we think that represents really good value and very inexpensive business for us to pick up because we're managing it anyway. So we like those kinds of deals and we look forward to doing more of those kinds of deals at the right points in the cycle. Tom?

So, Michael, that investment was not reflected in our acquisition guidance. So, it's not reflected as part of the numbers shown on Page 8 incremental to that.

Your next question comes from the line of Vance Edelson from Morgan Stanley. Your line is open.

Hi, guys, good morning. Looks like you expect stabilized development yields to even out globally by 2015 and beyond, settling in around 7% versus the range by region we see today. That could suggest either you're not sure so you just estimate everything will come out around the same or in your case, I'm guessing, there's some good analysis behind it. So, how confident are you that the development yields will increase slightly in the Americas and Asia while coming down by a percent or so in Europe?

I'm not sure that's the math. We don't do it that way. Put it this way. The way we do our development forecasting is that we have some bottom line numbers, bottoms up numbers, from each region, in terms of their pipeline, which is pretty visible at this point certainly for the balance of this year and into next year. We kind of know the economics of those deals, plus or minus a little bit, and we crank them in.

So, it really varies depending on what the land is on the books for and whether that land was impaired, whether that land was acquired recently or a long time ago; so it's not as simple as just taking a region of the world and applying a yield to it and mixing it up. Really, you need to get more granular than that and it's pretty impossible for you guys to do that based on the information that there is out there.

And what's more important as Hamid was referring to the margin, right. So, when you look at the margin that we're expecting on starts for this year it's going to be in the high teens and we've been stabilizing in the low 20s and we're going to continue to see the benefit of our land bank that's under fair value -- under valued from a fair value perspective, benefit our starts and our stabilizations probably into 2016.

Thank you. Your next question comes from the line of Jeff Spector with Banc of America.

Great. Thank you. This is Jamie Feldman here with Jeff. So, can you guys talk a little bit about the supply story and what you're seeing across the markets versus where you were last quarter even at NAREIT, just in terms of supply risk? Then how you think that plays on to your expectation for rent growth, I guess even on a multi-year view, which you guys gave at the investor day for both rent growth and even the same-store outlook?

So, Jamie, it's Gene. I'll start with that. So, our view on the supply picture in the Americas really hasn't changed over the last quarter. There are three distinct markets that are sort of close to equilibrium, Houston, Dallas, and southern California. Some other markets, Baltimore for example, has got a lot of supply coming on line, but essentially it's those three and not much has changed. Quarter to quarter, some have actually dropped in terms of quarterly starts, some have increased, but more importantly, I think you need to look at what's happening in the big picture, what's in that pipeline and how does that compare to absorption.

We're pretty comfortable, frankly, that overall Dallas and southern California still have excess demand. Now, there's certain sub markets of Dallas, south Dallas in particular, that we think are over supplied and I think we talked about that last quarter. Houston has a little bit of excess supply but frankly, we stabilized two buildings in Houston this quarter, almost 300,000 feet. It's 100% leased and we'll continue to build product that's core for us in Houston and that's going to be catered to 30,000 to 100,000 square foot tenants; demand there is still pretty robust. So, again, it's a long way of saying not much has changed.

Relative to the second part of your question, I think it's the replacement cost rents. How is this really going to affect the rent picture, and let me give you sort of a big picture of what we see happening in the US. Over the last year, let's say, we think that the cost of construction, essentially the hard costs, have grown around 6%. We think land values are up around 12% and you've had some cap rate compression, and if you mix that all together, replacement cost rents are growing at sort of 2%-2.5% over that period of time.

Over the next year we think replacement cost rents are going to grow more like 5% because we don't see, frankly, that you don't have the cap rate compression in the equation as of right now. So, there are certain sub markets, I mentioned south Dallas, where we're going to have headwinds on rent growth, but overall we remain pretty bullish about it throughout the Americas.

So, Jim really quick on Asia and Europe. If you look at China, again tremendously under supplied today. I think our rent change on roll this quarter came in, in the low teens. We projected call it 6% market rent growth over the next four years or so and we're exceeding that. Japan again still under supplied. We're seeing pretty -- greater rent growth than we had originally anticipated is coming faster in Japan. You will see a little tic up in vacancy rates in the Tokyo market this coming quarter, maybe up to 5% or 6%, but again, not a concern.

Moving to Europe we're still under supplied in Europe. You don't really see new starts but for build-to-suite starts. There may be a handful of speck buildings than just a handful of sub markets. And I think in Europe we've seen again 11 consecutive quarters of positive net absorption, so we're really in pretty good shape as well from a supply standpoint.

Jamie, to tie it back to last investor day, I think we're right on track. If anything, we're a tad ahead in terms of timing, particularly in the US, we're a tad behind in Europe because of that cap rate compression that we talked about, but generally if you mix -- and we're ahead in Japan for sure. So, China is about on target. So, if you mix it all up together, I'd say we're on or slightly above plan given the size of the US and on the same trajectory as we had nine months ago or whenever we did that.

Thank you. Your next question comes from the line of John Guinee with Stifel.

Great, thank you. Nice quarter, guys. Quick question. If I look at your development spreads, is that before or after taxes and how are you guys handling just very complicated corporate tax differences between countries?

It is an after-tax margin, so we reflect all taxes in there and in the vast majority of the cases the actual tax that's embedded in those margins is fairly modest because we have the ability to, if we're contributing an asset into a fund, do it on a highly effective tax manner to minimize taxes. Then upon sale, any taxes are typically transferred or shared because they're typically entity sales, so the tax on that is pretty modest.

Thank you. Your next question comes from the line of Ki Bin Kim with SunTrust Robinson and Humphrey. Your line is open.

Thank you. Can you just talk a little bit more about your lease break commentary? I think you said 75% of the leases that were signed in Europe were central Europe. Is that the case next year and what does that mean or imply about the lease spreads overall that you might be seeing when you look out further than just the next couple quarters?

Okay, so in Europe, it's hard to say what the future is going to be exactly because we don't know what will be leased, but this specific quarter 73% were in central and eastern Europe and southern Europe. As you look forward for the next two quarters, the lease expirations that we see, so that obviously doesn't contemplate new leases, but the lease expirations are in that same sort of range. So, I would expect you won't see again a substantial contribution from Europe at least for the next two quarters in terms of rental growth. But I do expect as we push occupancies up into 2015, that Europe will begin to contribute more so than it has in this quarter.

Ki Bin, this is Tom. From an overall trending perspective, looking into next year, when you look at our lease expirations, and we show that on Page 22 of our supplemental, you can see on an our share basis rents rolling next year at 529 a foot, overall portfolios at 550 a foot. We think today, in place to market is about 90%, so we're under -- our portfolios under leased by about 10%, but when you look specifically at 2015, it is more than 10% under market and that's just the composition of the roll. The vast majority of the leases that are rolling in the next few years are post prior peak periods, a lot of them during the crisis, so you're going to see more than a 10% mark-to-market on leases that are rolling in the next year.

Thank you. Your next question comes from the line of Craig Mailman with KeyBanc Capital Markets.

Hi, just two quick ones. On same-store NOI you guys had a nice accelerating trend the last couple quarters, but you've also been helped out a little bit on the expense side. Does that become a head wind at all in the -- kind of the trend in the second half of the year? And then just the second question, can you guys just talk a little about the turnover costs this quarter and whether that's just skewed by a couple leases or more of a trend you guys are seeing?

Craig, this is Tom. It's not going to be a head wind for us as we look at same-store in 2014 or 2015. A lot of the expense benefit that's going on are just where we are in the cycle, lower bad debt expense, other lower slippage just via higher occupancy, so I don't think it's a trend that will impact us going forward.

And related to the turnover cost, we're doing more small unit leasing right now. That's what's vacant in the portfolio and that has higher turnover costs associated with it. We also have a higher ratio of new leases to renewals and new leases have a significantly higher turnover cost, so those two things sort of gave us a little bit of a spike this quarter. I think the best stat for you to look at is the turnover costs for the value of the lease, so that's at 9% this quarter. I don't think it will stay at that level. I think it will come down, but we will continue to have higher volumes in small unit leasing going forward.

Thank you. Your next question comes from the line of Ross Nussbaum with UBS Securities.

Hi, thanks. Good morning, guys. Can you talk about the [$1.8] billion of land on the books? I'm a little curious, if I divide it up between the US and Europe how much of the US land is, what I'd call legacy from the last cycle, and how much of it's been bought in the past couple of years; and maybe the same question on Europe although I'm assuming most of the land in Europe is legacy. And where I'm going with this is, I'm trying to figure out if you look at the value per acre, which saying US is like $140,000 an acre, how that book value compares to where you've been buying land lately.

So, the vast majority of it is old land because the new -- first of all, you say last couple years. The land market didn't really start moving until about 6 to 12 months ago, so there was very little liquidity in the land market, not a lot of trades in the land market. So I think really, by a couple of years ago you mean last year, and by definition that's a couple hundred million dollars of land acquisition that has not been put in production and has gone into the land bank. So I would say 80/20, so 80% of it is owned land, 20% of it is new land. That's not a scientific number but it should be directionally correct. Mike, any additional color on that?

Yes, another thing, I think it's important to point out the land that we have purchased here in the last couple of years worldwide, some 90% of that has had a building put into production right off the bat or -- I'm sorry, within the first 18 months. And you see in Japan that land gets put into production sometimes a week after we buy it, so I think we're doing a really good job there of managing our land bank going forward.

Thank you. Your next question comes from the line of Vincent Chao with Deutsche Bank.

Hi, guys. My question has been answered, thanks.

Your next question comes from the line of Brad Burke with Goldman Sachs.

Hi. Good morning, guys. Wanted to talk about development margins. Looks like this quarter saw a slight decline in your expected margins on new starts versus where you've been at for the past year or so, and I realize you've been telling us that we can't continue to expect 20% plus development margins. But I was hoping that you could elaborate on whether there's anything specific that would push these margins to a more normalized rate, because it sounds like rental rates continue to surprise you to the upside, or is one quarter just too choppy to make any conclusions about the trend in development margin?

The latter.

Okay.

I can give you a longer answer but it's the latter. And that number will come down to about 15%, but it will take a few years because we've got to work through this old land before it does come down.

Thank you. Your next question comes from the line of Eric Frankel with Green Street Advisors.

Thank you. You talked a little bit earlier about release in spreads and rent growth trajectory. Can you just maybe touch upon the vintage of leases that are rolling over now, maybe the percentage that were signed post 2009 and percent pre-2009? Thank you.

Yes, so Eric, let me start with Q2. The leases we signed in Q2 this quarter, 5% of them were signed before June of 2008, 95% of them were signed after June of 2008, and of those after 2008, 35% were in the trough. Okay? If you look at our overall portfolio as of 06/30, 15% were signed before June of 2008; therefore, 85% signed after, 30% during the trough. So, net-net we think we've got a pretty good runway of below market leases rolling for the next couple of years.

So, one other factor that I want to bring in, this would be a good time and follow-up to Eric's question, to make you all aware of. I think it scratched my head quite a bit as to why consistently the same-store NOI forecast that you guys put out are low in this improving part of the cycle. I think we have not done a good job of communicating something that happens to our business which I want to just outline for you.

Basically, if you take our rollover schedule on an annual basis, and let's make it simple, let's say we're signing five-year leases on an average 20% of the portfolio rolls over.

That understates the real rollover and the ability to move up rents at the good point of the cycle by about 30%, maybe a little more than 30% at times. So, if this theoretical number of rollover is 20%, the actual number in a given year may be 25%-26% of the overall portfolio and that number is about 30% in the good part of the cycle because the lot of tenants that need more space, less space, different kind of space, and they have old leases; they come to us and say, we would like to tear up that lease, we'd like to take the expansion space, we'd like to do something different than when their lease technically expires, and of course if we're in an up market we like doing that because we can get their space back and lease it up at the higher rent and lease some new space at the higher rent.

So, in a rising market the turnover statistic understates our opportunity to capture upside in rent. Now, you might ask what happens in the downturn. In the downturn does it go the other way? It doesn't really because unless there's a default we're not going to write down the rent to market in case of a voluntary early termination of the lease.

So, the portfolio has a quicker ability to adjust to the upside when rents are escalating as much as they are now. And once you include that in your analysis, I think you'll get a lot closer to the kind of same-store numbers that we've been talking about and finally getting close to achieving. So, going forward don't be surprised if your turnover ratios don't back into the same-store NOI that you'll see coming through in our portfolio.

So, an example would be the same-store pool for the last four quarters we turned 23% of our same-store leases.

Anyway, I hope that helps.

Thank you. Your next question comes from the line of Michael Mueller with JPMorgan.

Thanks. Hi. It seems like you're seeing more acquisition opportunities. I was wondering what you think is driving that and is there a regional bias to it?

We are seeing more acquisition opportunities in two places. One, what we talked about some proprietary deal flow through our funds and, by the way, we don't do every deal that becomes available in our funds either, we only do it when we see value. There are cases where there's been opportunity to deploy more capital in our funds and we've just not availed ourselves of that opportunity.

The second place is Europe. While cap rates in Europe have compressed rapidly faster than our expectations, we still think there's another 6 to 12 months of cap rate compression left in continental Europe. So, don't be surprised to see us be a pretty active acquirer of assets in Europe at below replacement costs. So, those are the two places that I would guide your attention.

Thank you. Your next question comes from the line of Michael Salinsky with RBC Capital Markets.

Good afternoon. Hamid or Gene, can you talk a bit about the strength you referenced in the small block space, maybe put a little bit of numbers. What kind of spreads are you seeing on small block renewal right now versus some of the bigger bulk space?

Yes, it's Gene. That's a good question. So, in small unit leasing we've increased occupancy pretty substantially over the last couple of years but we've got a ways to go, so we're in the Americas 92 and change, but the real story is the rent spreads. We are over 12% rent spreads on small unit leasing this quarter and that's had a nice run like the rest of the portfolio over the last four quarters and we think that will continue. We think about replacement costs analysis for these small units, we are way below placement cost rents right now, so there's actually more upside in that segment. So, we believe that's going to continue.

I would just say we've got a similar focus in small spaces in Europe but we just don't have the pricing power at this point in time. So we need to get to a place where the Americas is where you're plus 90%-92%, in that segment, and then we'll start pushing rents in that segment; but we're not there yet.

Thank you.

(Operator Instructions)

Your next question comes from the line of Michael Bilerman with Citi.

Thank you. So, I just wanted to follow back up just in terms of the ample liquidity, Tom, where you talked about there was obviously an increase in the net deployment. I think net deployment today is about $200 million. I take it that the contributions falling into the first quarter of next year, which is about $400 million at 50% share, would effectively take care of that, but how should we think about the increase in the fund which is gross capital equity, plus your share of the debt of about $480 million? How should we think about your desire to deploy and effectively increase funding? Where are you going to get that liquidity from with the goal of continuing to improve the balance sheet?

Going forward, as you said, when you look at the match funding for 2014, it's really in line because when you look at starts, starts don't translate into cash flow. So from a cash flow perspective you talked about a net $200 million, it's actually much smaller. It's actually about the same from a net cash flow perspective, and then we have contributions coming in the first quarter, as well as expectation that we would see continued contributions stabilize -- I'm sorry, development stabilize and roll off. So, I think we can mostly self-fund going forward at this stage and any incremental capital longer term we're going to finance in line or capitalize in line with our long-term goals which are mid to low 30%.

The only thing I would add to what Tom just said is that we're going to -- obviously as we, I think, mentioned earlier in the year and we continue to want to take advantage of a good disposition environment for selling the little bit of remaining non-strategic assets that we have; so we're stepping on the gas in the back half of this year and early next year to do that.

Thank you. Your next question comes from the line of John Guinee with Stifel.

Great. Looking at your Japanese REIT and your public vehicle in Mexico, is it possible to understand how those entities are trading on an implied cap rate basis right now?

I think the Japan number, I haven't looked at it in awhile, it's in the high 3's and the Mexican REIT is in the mid to high 7's. But I mean, you have to listen to their calls, too, to figure that out.

Thank you. Your next question comes from the line of Jeff Spector with Banc of America.

Thanks, it's Jamie Feldman again. So, Tom, I'm wondering if you can just walk us through the change to guidance at the mid point in terms of what were the main moving pieces. And then as we think about FFO for next year, how much of that is recurring and how much of that is more one-time in 2014?

Okay. The $0.05 bump was primarily deployment, net deployment, some out performance from the first half, as well as a stronger our share of operations and interest savings. That would make up the $0.05. What I see from a year-over-year run rate basis, I don't see any of those being non-recurring. We obviously had a large promote in the second quarter and we believe that we're going to see promote levels pretty consistent, if not better, than we've seen in the last few years going forward.

At this point in the cycle we feel very good about our promotes that we're going to be earning over the next three to five years. So, I don't see anything that's in our results either year-to-date or in our forecasts that are meaningful at all from a non-recurring sample.

Yes, and the only thing I would add to that is that if you go back and look at our investor presentation from last September, we laid out some numbers for you that took into account sort of the rental picture and its growth and, as I mentioned earlier in response to your question, we're on track or maybe a little better than that. So basically if you look at that forecast and say if you're going to redo that forecast how would you change it, I would say on the rental side we're pretty even.

We've done a better job on managing our interest expense than before and I think we've done a better job on G&A. I think on both of those we're way ahead of the plan, so I would say those numbers are pretty good with an arrow up on them directionally.

Thank you. Your next question comes from the line of Michael Bilerman with Citi.

Yes, just last question. Just on the promotes and Tom, you just touched on this. Next year you have the opportunity to earn for the funds to promote it's about 35% of the assets in funds or in listed companies, almost about 55% of your equity committed to those. Can you give us, at least based on where the NAVs are today, what that gross number promote potentially could be for 2015, as we think about the FFO impact?

That would not be a good idea. First of all, we don't really know with any precision and, secondly, values can change around and it depends not only on the value that we think but the value that the appraisers think, et cetera. But, let me go back to something that I mentioned to you over the years. I think our gross promote is on the order of 25 basis points of third party assets under management across the cycle. It will be lumpy, but that's about what it works out to be across a normal cycle in terms of magnitude.

Now, from that you need to net out some things and get to a net number that hits the books, but -- so, if you're going to use a number I'd use maybe 15 basis points to get to the net number.

Michael, when you look across the last two years, we put up $0.04 in 2013, we just put up $0.15 to promote in 2014. I don't think those numbers are out of line when you look at the next three to five years. I'm sorry, $0.04 in 2013, $0.05 in 2014.

Yes which, by the way, $0.05 is $25 million and if you look at our third party assets under management at about $20 billion, it gets to that mid teen,15 net number that I mentioned to you. It's a little bit lower than that, but that's not a bad number for sort of a recurring kind of flow adjusting to lumpiness.

Thank you. Your next question comes from the line of Eric Frankel with Green Street Advisors.

Thanks. Tom, can you just go through the debt repurchases and just explain what exactly you mean by purchasing everything on an NPV basis that's meaningless, not meaningless but has no economic cost? Thanks.

Yes. So, when you look at -- when we analyze the economics of retiring debt early, we NPV that interest expense, the remaining interest expense on that debt, and we discount it back at our cost of capital, our cost of debt for that remaining term. And if that NPV is within 1% of the balance of that debt, we believe that's a good economic deal because less than 1% is a pretty deminimus amount to pay for the ability to lock in long-term rates. So, another way to look at it is if we could take that 1% delta and just amortize that over the remaining life of the debt we think that would be maybe 10 bips a year, so it's very deminimus and we think that's a very inexpensive price to pay to lock in today's long-term rates.

In the last 12 months we've locked in 10-12 year debt, albeit Euro, but we have the ability to issue it at sub 3%. We will do that all day long and we will continue to look at ways to do that, although that pool is diminishing rapidly but we think it makes a lot of sense to do that.

Thank you. Your next question comes from the line of Ki Bin Kim with SunTrust Robinson Humphrey. Your line is open.

Thanks, just a couple quick follow-ups here. What is the average contractual rent step-up in your entire portfolio and, second part, your cash same-store NOI growth has been out pacing your GAAP. Is that just truly because more than expect -- well, more than normal burn off of free rent and should that be closer going forward?

Yes. Ki Bin, this is Tom. So, from contractual bumps globally, about 80% of our leases have contractual bumps on revenue, of I would say, approximately 2.5%, so again that's on revenue, not on NOI, and the rest of our leases that don't have contractual bumps typically have some sort of an index (inaudible), so it's like a CPI inflator so you can't straight line it but it does give you a bump every year.

Your other question really is when will -- yes, cash NOI is outstripping GAAP today largely because of concession burn off and other -- basically concession burn off. Those two are going to converge over time, over a long period of time. They should be identical. I would expect they would converge, get very close to each other some time in the back half of 2015, early 2016.

Okay, great. That being the last question, I just wanted to thank you for participating in this quarter's call and look forward to seeing you at the next call if not before. Bye-bye.

This concludes today's conference call. You may now disconnect.