Prologis Inc (PLD) 2014 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. My name is Ryan, and I will be your conference operator today. At this time, I would like to welcome everyone to the Prologis third-quarter earnings call.

(Operator Instructions)

I would now like to turn our call over to Ms. Tracy Ward, Senior Vice President of Investor Relations. Please go ahead.

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

This morning, we will hear from Hamid Moghadam, our Chairman and CEO, who will comment on the Company 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 filing.

Additionally, our third-quarter results press release and supplemental do contain financial measures such as FFO and EBITDA that are non-GAAP measures; and in accordance with Reg G, we have provided a reconciliation to those measures.

With that, I'll turn the call over to Hamid, and we will get started.

Thanks, Tracy, and good morning, everyone. It's only been a month since our last investor event, so I'll keep my comments brief. Our focus today is on real-time market conditions, the Company's growth objectives, and our results.

Let me start with a few observations about the operating environment. Despite cautious macroeconomic headlines, our global markets continue to benefit from decent demand, with occupancy and rents rising. In the US, net absorption is running at nearly double the pace of completions, and vacancies are near all-time lows in many markets. There are, however, a few markets where supply has caught up, and vacancies will be trending higher in the next year, such as Indy, Houston, and Dallas.

The transaction market remains very competitive, and there is significant capital chasing quality product. As is often the case, the private markets are ahead of the public markets, and maybe themselves, pushing cap rates to historic lows. We now see stabilized cap rates below 5% in a growing number of our global markets.

Turning to Europe, on the operating side of the business, demand is improving, despite ongoing macroeconomic uncertainty. Northern Europe and the UK are leading the recovery, with high occupancy levels and the ability to push rents. Although we've begun to see markets recover in parts of southern, central, and eastern Europe, it will take time for rental growth to materialize in those regions.

Investor demand for industrial real estate is robust, as capital continues to flow into Europe. These inflows are compressing cap rates, creating an additional headwind for market rent growth.

On the deployment side, the key is to be nimble in this changing landscape. We believe the window for portfolio acquisitions is closing quickly, and, as a result, our focus will turn towards one-off deals where we can add the most value. Having a team on the ground with the ability to source investments provides us with a competitive advantage. As opportunities to acquire discount to replacement cost dissipate, development will become a larger part of our overall deployment activity.

In Brazil and China, operating performance is better than the headlines. Despite downward revisions to forecasted GDP in Brazil, demand for its Class A logistic space exceeds supply. And in Japan and Mexico, we continue to experience strong market conditions. In Mexico, for example, demand has improved in border markets due to an increase in near-shoring activity.

Let me now turn to some specifics about our results. The third quarter was good, with momentum across our business lines. Our results were led by operations. Occupancy reached 95%, with rent change on rollovers increasing to just under 10%. And we've now seen seven consecutive quarters of positive rent change on rollovers.

Given current asset pricing, we're placing a greater focus on non-core dispositions in the US. Looking to value creation, this is a good time to be in the development business, as long as you have an attractive land bank. Margins on stabilizations are still well above average, and we have a good pipeline of proposals and pursuits.

On the strategic capital side, we have a healthy investment queue, with strong interest for all our offerings. Year to date, we've raised more than $1.4 billion of third-party capital.

To sum it all up, our strategy is simple, and we have meaningful embedded earnings potential from harvesting the gap between our in-place rents and market rents, and through the buildout of our land bank, an asset which is undervalued on our books by about 20%. Our financial position is solid. We have ample liquidity, a well-laddered debt stack, and we're hedged against foreign-currency fluctuations. As always, we will be patient and disciplined in our approach to the Business.

With that, I'll turn it over to Tom to discuss results and guidance.

Thanks, Hamid. I'll start with our results for the third quarter. Core FFO was $0.48 per share. Leasing volume for the operating portfolio was 37 million square feet, an increase of 8 million square feet over Q2.

Quarter-end occupancy was 95%, up 40 basis points from the second quarter, and 110 basis points year over year. The sequential increase in occupancy was driven by Europe and spaces under 100,000 square feet. GAAP rent change on rollover was 9.7%, positive across all regions, and led by the US at 15.5%. Cash rent change on rollover was positive 1.6%.

GAAP same-store NOI on an owned and managed basis increased 3.7%. The main driver of the growth was a 2.9% increase in revenues, which consisted of an increase in average occupancy of 120 basis points; rent growth of 150 basis points, as almost 26% of our leases in the same-store pool rolled in the prior four quarters at an average rental increase of 5.8%; and about 30 basis points from indexation.

As we discussed at our investor event last month, the majority of our share of NOI is from the US, due to the fact that 60% of our portfolio is located here, and we hold almost all of our foreign operating assets in ventures. GAAP same-store NOI on an our-share basis in the third quarter was about 4%, driven by the US with growth of 6.3%. On an adjusted cash basis, owned and managed same-store NOI grew 4%.

Turning to capital deployment, during the third quarter development stabilizations were $223 million, with an estimated margin of 26%, well above our long-term expected margins. We generated $57 million of our share of value creation, or $0.11 per share. Development starts totaled $698 million, with an estimated margin of 19%. We acquired $884 million of buildings, with $367 million our share at a weighted average stabilized cap rate of 6.1%, primarily through our co-investment ventures in Europe.

Contributions and dispositions totaled $802 million, with our share at $728 million at a weighted average stabilized cap rate of 6%. We invested $357 million in our North American industrial fund, increasing our ownership interest to 63% at September 30. Subsequent to quarter end, we increased our ownership to 66%, and we will begin consolidating this venture in the fourth quarter.

Turning to strategic capital, revenues were $54 million in the quarter, with 93% of our asset management fees now coming from perpetual or long-life ventures. We raised $500 million of third-party capital for our China logistics venture in the quarter; and year to date, we've raised $1.4 billion for our strategic capital vehicles.

Switching gears to capital markets, we've redeemed $581 million of bonds and secure debt during the third quarter. Subsequent to quarter end, we issued a EUR600-million bond with an annual coupon rate of 1.38% and due in 2020. The majority of the proceeds from this offering were used to match fund our euro asset [growth]. As we've done over the past year, we'll look to take advantage of the current interest rate environment to enhance our debt stack.

At the end of the third quarter, our US dollar net equity stood at 89%, double the level at the time of the merger, and essentially at our long-term goal of 90%. We've been very diligent on this front, in order to be well prepared for a meaningful move in foreign currency, like we witnessed this quarter. As a result, we have significantly mitigated the impact of FX movements on our earnings, and more importantly, on NAV. From a sensitivity standpoint, if all foreign currencies moved against the US dollar by 5%, NAV would move less than $0.25. From an earnings perspective, with the same 5% currency move, core FFO would be impacted on an annual basis by less than $0.03.

Moving to 2014 guidance, we are increasing our year-end occupancy range to between 95.5% to 96%. We're narrowing the range and increasing the midpoint for owned and managed GAAP same-store NOI growth to between 3.5% to 3.7%. On net G&A, we expect the full year to range between $240 million and $244 million.

For capital deployment, we're narrowing the range in development starts to between $2 billion and $2.2 billion. We're increasing the range on building acquisitions to $1.5 billion to $1.7 billion. Note that this relates to third-party building acquisitions only, and excludes our investment in NAIF. We're maintaining our contribution guidance of $1.6 billion to $1.8 billion; and for dispositions, we're increasing the range to $1.4 billion to $1.6 billion. For strategic capital, we expect revenue to range between $215 million and $220 million.

Putting this all together, we're narrowing our full-year core FFO range to $1.85 to $1.86 per share, which is at the high end of our previous guidance. This represents an increase of $0.015 at the midpoint, and year-over-year growth in core FFO of over 12%, and full-year core AFFO growth of over 20%.

In closing, we had another solid quarter, and I'm pleased with the progress we've made to enhance our financial flexibility. Looking ahead, despite an uneven macroeconomic environment, we are well positioned to continue to grow as we begin rolling our lowest rents to market, stabilize more developments, and put our land bank to work. With that, I'll turn it to the operator to open up for questions.

(Operator Instructions)

Ross Nussbaum, UBS.

Good morning.

Hamid, you open the call with some comments about supply having caught up in a few markets. I'm curious, when I look at the CBRE data for the third quarter, it showed 60 million square feet of demand, or net absorption against 30 million square feet of deliveries, which obviously implies that demand is still exceeding supply in most markets. Which of your MSAs are you seeing for the greatest disparity between where demand is, and supply, on the positive side?

In terms of surprise, the Inland Empire has had very strong absorption. We were a little worried about that market, I think, the last time we talked and we were surprised by the upside in absorption. But in terms of actual GAAP for the quarter, I don't carry those details in my head.

I would say the three that stand out the other way are the three that we mentioned. But most other markets have a deficit, and some have a pretty significant deficit.

Gene, do you know, can you give Ross more color the markets?

Yes. Ross, there's certainly a few markets in the US where you have dramatic imbalances, and why don't we follow-up with you on the details? The way we look at this though is -- and we look at our own portfolios, where occupancy is at, relative to that particular market.

And for the purposes of this call, we focus more on where we are concerned about oversupply, and as we've mentioned, there's a couple of spots where we see that. But if you look at the aggregate numbers, obviously we're 2X demand versus supply.

Thanks.

David Toti, Cantor Fitzgerald.

Great. Thanks.

Hamid, I want to follow-up on the first question and broaden it a bit, in terms of -- what does the Company look for relative to the development landscape, in terms of signals that would cause you to potentially pull back on volumes, especially around spec? Obviously the supply levels are one, but is there a point where yield thresholds become problematic, as well?

Sure. Let me -- I have the chart in front of me on deficits. SoCal has a pretty big deficit. San Francisco Bay Area has a huge deficit, and Seattle has flipped to a pretty big deficit.

Southern Florida, which is Miami, has a big deficit. Baltimore-Washington has a big deficit. So those would be the markets at the moment where the run rate -- 12-month run rate of absorption is significantly higher than the delivery, so that's just to answer Ross's question.

In terms of signals that we look at, these buildings are -- the good thing about the industrial business and the bad thing about the industrial business is that these are small, relatively small incremental investments. We're not building 1.5 million mass square foot office building that in two years, we'll find out whether the market is good or not. We are delivering fifth or sixth building, usually, in a park. The park is already full. So it's very incremental.

So we are not geniuses. If we put up a building and it takes too long to lease up, we don't put up the next one. And we manage our exposure that way. It's maybe a little bit more sophisticated than that, but not a whole lot more.

Brendan Maiorana, Wells Fargo.

Thanks. Good morning.

I wanted to ask about the dispositions and contributions. I think you mentioned that you're looking to increase the level of non-core dispositions going forward. If I look at what you put on page 28 of the supplemental, overall dispositions were, I think, around $800 million in the quarter, average cap rate was 6%, but it was skewed by Japan, which is low cap rate market and suggests that what you sold in the US was at relatively high caps. So how should we thing about the dispositions that are slated for the remainder of the year and next year, and the cap rates or income loss that you're likely to get from what you sell?

I would listen to our guidance, because that will be baked into our guidance. But generally you shouldn't be surprised that our dispositions are at higher cap rates than our acquisitions in the equivalent markets, because we are selling the bottom 20% of our portfolio, so that shouldn't surprise you. The fact that we've done better than that in the last two, three years is because cap rates have compressed a lot, so we've sold stuff at a lot better cap rates than we thought we would. But we're okay with that, and that is actually baked into any guidance we have provided to you.

This is a $50 billion company. We can't sort of spend our time talking about 200,000 square foot buildings here and there, so we have to take a more aggregate view of it.

Brad Burke, Goldman Sachs.

Thanks. Good morning.

Wanted to ask about the rent spreads that you saw in the quarter, clearly a nice improvement quarter over quarter looks like, both in the US and outside the US. I think it's fair to say that the overall macro sentiment outside the US did not improve in the third quarter. So, I was hoping that you could comment on what you're hearing from your tenants overseas, how you're thinking about the momentum in the market rents either positive or negative from where you are now, and what you're thinking about going forward?

Okay. So I'd say customers in Asia are still quite optimistic, demand still exceeds supply certainly in Japan and China. Our rent spreads in both those markets were quite wide this quarter. I think China quite wide.

In Europe, it's really more about consolidation. The big themes for our customers were 3PLs and e-commerce, which really were driving. Expansion was heavy, I would say, and jinxed, because it is more in the US and Asia. Not so much in Europe: was really more about consolidation.

And in terms of the customers that were most active this quarter, consumer goods were very active. Pharma, and those are really the two that I think were driving. Automotive, I suppose, as well. All of those were up over the last quarter and above historical averages. But again rent spreads in Europe pretty significant in the UK and Northern Europe, and not so in other parts. Again -- we squeaked out slightly positive rent spreads of this quarter in Europe, as we were growing occupancies.

But I would add to what Gary said is that there are definitely some markets in Europe where rent spreads are negative. France would be one, where you get under the 369 structure escalating rent, and then when you get to the end of that, you fall off. Central and Eastern Europe, you were renewing at below, in some cases, below in place rent. So it's a seesaw. There's some positive, some negative, and I think it's about even right now.

Right.

Eric Frankel, Green Street Advisors.

Thank you. Tom, can you explain the pretty big gap -- pretty big difference rather, between cash and cash and GAAP leasing spreads?

Well, we've talked historically that we would expect that spread to be 6% to 8%, and it was right on 8% this quarter. Almost right on top of that. So it's tracking exactly where we thought it was. And as we talked about at the investor day, if you think about the GAAP rents increasing by contractual rate to 2.5% to 3% a year, and you look at a four- or five-year lease, and you compare you're going to take the midpoint of that net effective GAAP rent, lease over lease, and you're going to take the cash rent that's probably only going to grow call it 3% or 4%, whatever that's in a normal market. So that's how you get that 6% to 8% spread that we would expect.

Vance Edelson, Morgan Stanley.

Terrific. Thank you.

You mentioned the uneven macro environment, and even in the US, the data points have at times been conflicting over the past quarter. Is there anything you can share regarding the pace of your US leasing activity? Was demand generally improving during the quarter? And would you say you're getting any type of holiday-related lift from the consumer goods segment?

Yes. It's Gene. I'll take that one.

Demand is definitely accelerating in the US. It's a bit early in the third quarter to talk about holiday demand, but we're seeing that right now. But overall, we're seeing very good broad-based demand.

We talked in previous calls a lot about the housing business, and that's a catalyst that we are looking to kick in. And while housing starts have disappointed the economists and probably all of us generally, they are up over 15% year-over-year, and we're seeing that come through primarily in small spaces. Our small spaces, under 100,000 feet are up about 290 basis points year-over-year in terms of occupancy, so that's something that I would highlight. The overall numbers aren't huge, but that's driving demand.

But we're just really optimistic and happy with the nature of the demand. We don't have any weak markets. We don't really have any weak submarkets. And I would say we had some acceleration in demand through that quarter.

Michael Bilerman, Citi.

This is Kevin Varin with Michael. As you think about the increased capital you have committed to acquisitions sequentially, and also when you add in the buy-in of the additional stake in the North American fund, how are you think about funding that in order to stay leverage neutral. And then I guess, are you comfortable moving up leverage, or should be assume you will get more dispositions or will you seek to raise common equity either on the ATM or in issuance?

This is Tom.

So from a standpoint of funding our growth, right now, today our line stands fully undrawn today. We had a balance outstanding at the end of the quarter, but we took that out we in we did our Euro bond in early October, so we're sitting on significant liquidity.

When we look at the first half of 2015, we see some pretty meaningful contributions that will be happening and some other dispositions. So we feel really good about our ability to fund our incremental growth.

That being said, going over the long haul, we are going to want to run this business in the low to mid 3% LTV, and as we have incremental growth, we're going to have to fund that consistent with that long-term goal. And if that means issuing equity off the ATM, we'll do that at the right time.

But not at the discount to NAV.

Jordan Sadler, KeyBanc Capital Markets.

Can you maybe drill down a little bit on Europe and on a forward-looking basis? Obviously, you continued to see the escalation and occupancy, and the traction there. But there's some puts and takes in terms of by country. Just expectation in terms of going forward. What we should expect on the occupancy front there, if that will offset potential rolldowns that you may see.

Yes. Sure.

So as we've said over the last couple of quarters, we started to solve for occupancy in Europe, where we need to, and are having difficulty pushing rents. And that strategy, I think, has played out certainly this quarter as we are up 90 basis points. And it's been pretty broad-based.

If you look across our core regions, Southern Europe's up 130 basis points, UK's up 90, CE up 80, and Northern Europe up 60, so we are certainly being able to drive occupancy levels. I'd say there have been some notable surprises, some markets that have been lagging, that continue to like to a certain extent, but we have got traction, and now, which is Hungary, France, and Italy. I think that would have been a surprise to the upside.

In terms of being able to hold onto that occupancy, I feel certainly good about that going into the fourth quarter. But you just need to look at our lease to occupancies spreads, and they're pretty significant and growing, so I'm very confident that we're going to hold this occupancy to the fourth quarter and beyond. Again the one thing that out of our control is the macroeconomic environment, and that is something that we're tracking, but it's something that we don't control, so we're highly focused on our own operations.

Jamie Feldman, Bank of America Merrill Lynch.

Great. Thank you. So it looks like you took down the high end of your of deployment starts guidance slightly. Can you just talk a little bit about what drove that? Is it just stuff that will get pushed into next year? Or are there some markets where you think it is time to stop developing, and then how we should think about this heading into next year for starts?

Jamie, this is Mike Curless. We're at the stage of the year were all of our remaining projects are identified, and so we have full visibility on what we expect to do by year end. We're highly confident that the volume we will see in the balance of the year will be at or above where we came through in the third quarter.

So nothing significant going on there whatsoever. We're highly confident in terms of what we'll see for the end of the year, and then into next year, we're very confident about volume going into the first quarter.

Ki Bin Kim, SunTrust.

Thanks. Just a couple quick questions regarding your same-store NOI growth trajectory going into next year. If I go back to your investor presentation, it seems like 50 basis points is assumed, that comes from CPI indexation from Europe, and another 50 basis comes from amortization of lease intangibles. So my question is, if European CPI remains zero, which is what it's been so far, do you see any other levers of growth that can come to compensate for that? And also second question is, on amortization of lease intangibles, I would think that would be a negative, not a positive adjustment to your GAAP rent change. I'm just curious if you could just help me understand why that contributes to 50 basis points of growth.

Ki Bin, this is Tom.

So a couple things on same-store growth next year. I think there's opportunities from an OpEx standpoint that we could see -- we should see our revenue growth exceed that of our OpEx. I would expect that, which certainly helps NOI growth. I would -- I think there's -- we have talked about occupancy -- average occupancy increase for next year in that illustration, not guidance, of 50 basis points. I think as I see things today and where our occupancy is, we could -- that could be better than 50 basis points next year.

And then on your second question regarding the lease intangibles, that works both ways. So a lease intangible, when you have a purchase accounting event or an acquisition, you mark those leases to market, either above or below market. And when those leases happen to be above market, you might be getting cash rent of $5 and market might be $4.50, so GAAP says okay, that $0.50 delta, you need to take that, even though you're getting cash in the bank, you have to reduce that from your revenues.

So that's what happening with that amortization. It was just a timing of when that intangible was set up, it was set up in the downturn.

Yes. And let me add one more thing and draw your attention to page 22 of the supplemental. So we have new disclosure on what our rolling leases look like in the next couple of years. So without getting into detail, if you do some quick math around where our rent change is today, and what is expiring in the future, think that'll help you out with the rent growth side of the equation.

And the other thing I would add to it -- the one thing that we can really debate around here is how much rents are going to grow, but I can tell you in the Americas at least, if you look at our occupancy levels, if you look at the market occupancy levels, six of our global markets are at all time occupancy highs. 10 of our Prologis markets are 97% leased or better.

I can't think of a better environment for pushing rents. Now that's going to change over a long period of time based on supply, but if I think about how was our potential for rent growth and then look at what's rolling, I think it stacks up pretty good. But page 22 should be helpful to that.

Vincent Chao, Deutsche Bank.

Just wanted to go back to the housing starts, and some of the traction you're seeing on the smaller side of things. Just curious, if starts continue to slow, just curious what level you start to get a little bit worried about some of the housing-related demand, and some of the demand you're seeing for the under 100,000 square-foot tenants.

Yes. Well, as I said earlier, right now, it's on fire. And the other thing we haven't talked about is, what is our rent growth potential? And I think if you looked at some call scripts from a year ago or two years ago, that segment, rents absolutely plummeted, but replacement cost is really high in that segment. So our rent change in the last quarter for smaller spaces was 15.5% in the Americas, so a big rent change along with occupancy pick up.

Getting back to your question, it isn't as if we've seen huge demand from the housing sector. I'm just pointing out that starts year-over-year actually are up, so if we still are bound at 1 million units a year, I don't think it's going to impact demand in that segment. If it goes to 500,000 units, back to where it was in 2009, then we probably have some issues, but we don't really think that's likely to happen. In fact, we think it will pick up marginally from 1 million units a year.

Gabriel Hilmoe, ISI Group.

Thanks.

Tom, just going back to the GAAP rent spreads and looking at the fourth quarter, what's being baked into the fourth quarter with guidance? And then, can you give a sense of the geographic mix of leases rolling in 2015?

Okay.

So, as far as what our guidance for same-store implies, for Q4, it's really right in the range. I think year-to-date, our same-store growth is around on a GAAP owned and managed basis, is around 3.5%. So we were expecting Q4 to range between 3.5% and 3.7%.

When we look at mix going into 2015 versus 2014, I think three regions stand out. The first would be the central region in the US. That has had a disproportionate amount of leasing in 2014. It would be our lowest rents of any of our regions in the Americas, because of where it's located.

And then the other two regions would be Southern Europe, which is France, primarily, and Central and Eastern Europe, highlighting Poland. And consistent with what I said on our investor day we had a higher roll in those two markets than we normally have, and that normalizes in 2015.

So, as Gene said, when we look at rents rolling next year, and where they are rolling, we feel really good about our rent growth, because we are putting up 9.7% today, and on an apples and apples basis when you look at mix, where we are signing leases today and where we are rolling these leases next year, we certainly expect that rent change to accelerate, just based on where rents are today. That's not predicated on any significant rent growth to hit higher rent change numbers next year.

Dave Rodgers, Robert W. Baird.

Yes. Good morning.

Maybe for Hamid or for Gary, obviously, pace of acquisitions in Europe accelerated and continues to do so, which is good to see. At a 6% cap rate, or just over a 6% cap rate in Europe, and say a 5% or so in the US plus or minus, at what point does that rent growth in Europe really kick in to get you to the point where your returns are equivalent? What's your forecast for rent growth in Europe that makes a 6% there look as good as maybe a 5% here, given the robust commentary on this call, and over the last couple of quarters about outsized rent growth in the US?

I think 6% cap rate would be not an accurate reflection of the opportunity in Europe. I think you will see a pretty heavy dose of UK in that.

London specifically.

London specifically, and London has probably got a higher rent growth then the US. So if you look at Continental Europe, I think cap rates are more in the 6.5% to as much as 7.25% range, and on equivalent quality of market, that's about a 200 basis point premium to the same markets in the US, because in the very best markets in the US, you're in the high 4%s. And while in the short term rental growth in the US is much better than it is in Europe, we think that the discount to replacement costs in Europe will drive rents in the long-term.

I think more of the US rental growth -- market rental growth, not in our portfolio, but because there's a lag, but market rental growth, has already taken place. We think we're actually probably 80% plus into the gap between spot market rents and replacement cost rents closing the gap we talked about three years ago in our investor day. So the rest of the way from here is the last 20%, plus any inflationary growth we may get from the US.

In Europe, we're early in that gap closing, and actually the compressing cap rates are delaying and extending that rental recovery, because you can build a new product with lower rents in a declining cap rate environment. So anyway to summarize it all, put the UK aside. We're really deploying capital in Europe and in the high 6s or low 7s. Call it mid-6s to low 7s, and we think that's a pretty healthy premium in growth. In other words, when you combine that with lower growth, we think that still gets you better total returns than the US going forward.

Still huge discounts to replacement cost just to accentuate what Hamid was saying, and you don't have supply coming onto the market today in Europe.

Mike Mueller, JPMorgan.

Just going back to dispositions, and if you look out to the next couple of years, 2015, 2016, are the numbers you are talking about increasing the pace to significantly different to what you're doing now in 2014?

No. I think you're going to see our disposition activity really moderate. As we've been working hard since the merger, we've really worked down our other markets, our regional markets are getting close to 10% of our long-term target. And we'll see a mix -- we'll probably see more dispositions coming out of Europe in the next year or two, and less in the US and that's just timing of where we see the markets.

Yes. Just to be clear and reconciling those two comments. We are going to sell more of everywhere, particularly the US sooner than we would have otherwise. But we're actually running out of non-strategic things to sell. So we're getting to the end of that portfolio clean-up process, but whatever's left is going to -- we're going to keep on doing it.

Tom Lesnick, Capital One Securities.

Thanks for taking my question. With regards to the land acquisitions you made during the quarter, are you taking more of a just-in-time inventory approach there, or are you more just opportunistically banking it for the right time?

This is Mike. Our land strategy is exactly what we've laid out over the last couple years. Our long-term target for the land bank still remains at $1.5 billion, and we intend to get there over the next couple of years, which will give us a two-year supply, as we said, for the development pipeline going forward.

But as you look at the next couple of quarters, we're going to continue to restock in strategic and selected locations and global markets like the UK, Brazil, Tokyo, and the Bay Area, so we can get ready for the development volumes we expect in 2015 and 2016. And then later in the year, you got to see our monetizations kick in from development, and we'll continue our strong progress of selling nonstrategic sites, so at the end of the date you're going to see our land bank go directionally to that $1.5 billion target. Not going to happen in a straight line, but we're making good progress there.

Michael Salinsky, RBC Capital Markets.

Thank you. Just given your comments about mix changes and the higher relative to US exposure, do have what the releasing spreads for the quarter on a proportionate basis? And then as we think about 2015 and 2016, you referenced page 22 there, where you provide the expiring rents. Can you quantify how that -- how those in place rents compared to market, and what is the mark-to-market in place today?

All right. This is Tom.

So don't have the proportionate numbers on hand, but if you think about just our share of the NOI in the Americas and the US is about 72% to 73%. Europe's 23%. Asia's the rest. That's the allocation you will want to do for that.

And then regarding where market rents are again, I'll let Gene weigh in if he wants, but when you look at on an apples and apples basis, we're at -- we did rent change of almost 10% this quarter and from on a mix basis of what's rolling next year, we have lower net effective rents next year than what's rolling this year, absent any rent growth. And we would expect with today's rents to roll -- well, to have higher rent change next year than this year.

Steve Winoker, Oppenheimer.

Thank you. Can you just talk to me about why the taxes went negative this quarter? Thanks, Tom.

Yes. So we had a deferred tax liability of about $30 million, and it related to a built in gain on an acquisition from a very long time ago. And the statute on that ran, and we released that liability.

Now, that did not affect core FFO in any way. We don't take the benefit of any deferred tax benefits in our core FFO, so that was just a release of a liability that we had to put on our books at the time of the acquisition.

Contingent.

Contingent, and we wrote it off as a non-cash event.

John Guinee, Stifel.

They are getting better.

I got it. You should hear what they call me.

Just a quick and simple question. Too tired now. Recently, about this time last year, you raised your dividend 18%, and I can't remember if that was to an elective dividend increase, or a tax-driven dividend increase. Can you refresh our memory as to why the dividend got raised 18% around this time last year? And what your thought process is currently for this year?

So John, our AFFO this year is going to go up more than 20%, which is why we raised our dividend 18%. From a tax perspective, if you look at our core AFFO pay-out ratio, which as you know, does not include any development activity, our core payout ratio is going to be around 92%, 91% or 92% in 2014.

But taxable when we monetize our developments, that's taxable events, and when you look at our development gains for the year, we will be paying out something in the range of about 75% AFFO in 2014. So from a tax perspective, yes, we do need to continue to increase our dividends, when you look at the amount of the development value creation that we are recognizing, and is being taxed.

Yes. The Feds do trump those as real gains and real money, and if we could get the Street to do the same thing we be in really good shape.

The dividend increase was in February of this year. I might have said last year. Sorry.

(Operator Instructions)

Brendan Maiorana, Wells Fargo.

Thanks. Hamid and Gene, I had a follow-up on some comments you made earlier in the call. Hamid, you mentioned that you felt like 80% of the disparity between market rents and replacement cost rents had been realized in the US at this point in time. Which, I think, going back to your 2012 or 2013 investor day, you thought sort of 25% rent growth was required to get margin rents up to replacement cost rents. So if 80% has been realized that's 20% out of the 25%. How does that -- which would suggest maybe 5% excess market rent growth beyond inflation.

But Gene, if I heard your comments earlier, it sounds like you think you probably can push rents more than 5%, given where occupancy levels are, and the fundamentals in your market. So I was just wondering if you can reconcile those two comments.

Yes. Let me answer first, and Hamid can finish it off. But yes, I do believe that, and there's two reasons for it. One, replacement costs continue to move, and in the US, they're not moving rapidly right now other than land, but land's going up very quickly, and I think you'll see an acceleration in replacement costs, so that dynamic continues to play into the equation.

But otherwise, we will get to a point where we will be able to push rents beyond replacement costs for some period of time. That's not going to be a long period of time, but if you're in a supply and demand situation, where there is basically no vacant space, you're going to be able to push rent, so we have to be careful that's temporary, because ultimately supply will come on. But for some period of time that will be true. Absolutely.

Yes. Let me just clarify, I think there are actually three components to rental increases that we talked about three years ago, and by the way, thank you for remembering that. Because at the time we came out with that forecast, most people thought we were crazy, and we are actually below in retrospect. But the first is just climbing out of the hole. Just getting back what we lost during the downturn, which I call the bounceback.

The second is replacement cost accelerating beyond inflation, because the contractors will start wanting to get their margins back. Land prices will go up, and all that. And the third is getting on the normal equilibrium inflationary track for rental growth.

My comment was that I think we're 80%, maybe even more, off the bounceback from the hole we fell in. We still have the above inflation replacement costs growth, because while the land portion has kicked in, the construction portion is about to kick in. I mean, we're getting -- we're seeing some high construction pricing in some markets. So I think that will propel rents for a while, and then we'll get on the normal inflationary track. And Gene is absolutely right, we are going to overshoot it for some time and then it's going to come back down to the trend line.

So I'm not saying the rent growth is ending, but here's what I am saying. Let me go on the record, and tell you what I really think about this. I think people are way too excited about the long-term rental growth picture in the US. Yes. You heard it from Hamid.

Rents in the US will not go up for 6% or 7% forever, which is why some of these people who are paying ridiculous cap rates are assuming their performance. Not going to happen. It may happen for a couple years, but it's going to revert down to more of an inflationary growth number.

On the other hand, I think everybody has written off Europe as a dead continent, and it's never going to happen again. I think they're wrong. I think they are where we were in the US, 2, maybe 2.5 years ago, and there are parts of Europe that are going to have -- have already had, the UK, fabulous rental growth and occupancy growth.

And I think if you look at where rents are going and the cap rates you are seeing, there have been some terrific bargains in Europe over the last 10 or 12 months, maybe two years, that people have overlooked, and I think those opportunities are going away quickly. They're getting snapped up pretty quickly. So I think people are too optimistic about the US long-term and too pessimistic about Europe in the long-term. Time will tell whether that statement is correct or not.

Eric Frankel, Green Street Advisors.

Thanks. Can you just go into a little more detail regarding the national industrial fund, where you decided to further consolidate the portfolio? What the game plan there? Are you not running enough fees there? Do plan to eventually introduce new investors to the fund? What exactly is happening?

Well, that was -- as you know, after the merger, we have two open-end funds in the US. We have USLD which is the old -- excuse me -- USLF, Which is the old A and B open-end fund, which is actually a true open-end fund. It goes out and raises capital every quarter. It can redeem investors who want to leave. It can bring in new investors, it can make new investments. It's a living, breathing, dynamic open-end fund, like an open-end fund is supposed to be.

The old NAIF was really a club deal with a couple of big investors; one really big investor and a couple of more smaller investors. And it really didn't have the right governance, because the smaller investors didn't have liquidity. The investors couldn't decide whether we could raise money in the fund, or not raise money in the fund. It hadn't acquired anything in a couple of years because it couldn't, so it missed the opportunity to take advantage of the investment opportunities that were available in the marketplace. It was really an ill-conceived vehicle.

So our strategy is very simple. We want to have few competing vehicles in any given region. We want to minimize the number of competing vehicles, and between the two, this seemed to be the one that needed to be rationalized. And the some of the investors in it wanted liquidity, and some of them didn't, so we accommodated the ones that wanted liquidity, and we are happy owning the real estate.

We know it well. We like the real estate. We don't mind having our money invested in it. And once we can do something about it and we control it, if that day ever comes, we'll do something with it, in terms of recapitalizing it. Meanwhile, we're happy holding onto it, and just basically, it's a static fund that will operate for the foreseeable future.

Michael Bilerman, Citi.

Apologies. Good morning. I haven't done that in a while.

I didn't think you'd ever be that quiet.

Nor did I. I wanted to come back to your comment about not issuing equity below NAV, because the opposite, obviously, you have the ability to do, which is to buy your stock at a discount to NAV, if you believe it's there. And I view that, if you think about the buying of NAIF, into assets you now manage, you can take that up the scale and buy into a company that you know extraordinarily well and has a lot of other growth drivers outside of its pure assets, in terms of the asset management business, the development business.

And Tom talked all about the liquidity that the Company is generating, and will generate into next year through some of the dispositions. And you have a lot of choices to put that liquidity, and you've obviously made that choice to invest a lot into NAIF, which is almost $500 million of equity commitments, but $1.1 billion of total enterprise value with your share of the debt coming on, it's just a lot of capital. I'm just wondering how you weigh buying into that versus buying your stock, which would have the same sort of implications in terms of capital commitments.

Excellent question. We did look at that, and by the way, every time and Gene comes to me and says why don't we buy more and more something in the US, I tell him, why don't we buy more of everything if you think it's a better deal.

Our conclusion was that actually buying into NAIF was a more attractive return on investment capital than buying our stock. I think a stock buyback has a couple components, an important signaling component and an investment decision. I don't think is purely an investment decision. We, unlike your clients, are not in the business of buying and selling our stock every day, so it's somewhat of a permanent directional choice. And it's got to be a pretty significant discount.

There is a discount. We're pretty -- we're not shy about telling people about what we think our NAV is. We think it's in the range of $43 with no value attributed to the development business. So and people may argue that it's $42 and we can have that debate, but it's in that range. This was a pretty attractive yield on investment capital.

And I think by buying our company, we would have a higher mix of everything that we invested in. Europe. Japan. Everything. This was a US investment, so they're not directly comparable yields, and we thought -- we just thought this was a much better use of capital.

This is not as permanent a decision as a share buyback either, because this -- I think we're going to end up doing something with this fund down the road, in terms of recapitalizing it. So in the meantime, we're happy to enjoy the yield, and to be more invested in the US, given the operating parameters here.

By the way, we're pretty active in Europe too, as you saw in the third party acquisitions. But stock buybacks are really at the end of the day what we compare a lot of our investments to, and there's healthy debate that goes on about that in the shop.

Jamie Feldman, Bank of America Merrill Lynch.

So, going back to your comment on rent growth, saying you think the market's a little too excited about the long-term rent growth in the US, and maybe not excited enough about Europe, where do you think there's still room for cap rate compression across your regions, and where cap rates have probably bottomed out?

Well, let's start with the statement that we've been wrong about cap rate compression in the last two years. We thought it wasn't going to happen, and it keeps happening, certainly in the US. I think there's a lot more cap rate compression to happen in Europe. That's for sure.

I think Japan cap rates are going to compress because the public market trades at 150-basis point lower cap rate. Sorry -- the public market trades at the 150 basis point lower cap rate than the private market. And that's the quirk of Japanese laws, where you can't really contribute assets to a JREIT at lower than an appraised NAV, so there's this disconnect between public and private markets. And public market value real estate much more expensively.

So those two areas I'm pretty sure about cap rates going down. My bet is that cap rates are stable or going up in the US when people realize that rents don't grow 6% a year forever. But I've been wrong about that so let's not acknowledge that.

And I think Mexico is going to have lower cap rates. Cap rates in Mexico are going to come down a little bit. But the big trade -- I think the big insight is that I think cap rates are flat to up in the US, and I think people are getting a little exuberant about industrial real estate pricing in the US.

Michael Bilerman, Citi.

Just one quick one, just on page 18 of the turnover cost. Gene I don't know if you could comment a little bit. But the trend line looks like it's going up to 9.3% of its prior quarter, and I would have thought the reverse. I would have thought that as your rent spreads are widening, the value of the lease is going up and rents moving up, that actually, you have to spend less to get the spread. Didn't know if there was something going on.

No. I get it. I get it. This quarter it's interesting. Every individual division actually dropped -- this is entirely mix. So we have more US deals, which have a significantly higher turnover cost, relative to others.

And of course, we're leasing more small spaces, and they have higher commissions and TIs. But I would tell you, Michael this has been pretty constant, pretty flat, and I think it's going to continue to look that way. So this is really -- it's really a mix issue, in terms of where we did leasing.

Michael Salinsky, RBC Capital Markets.

Thank you. Just given your comments about non-core sales versus potential issues, what percentage of the portfolio today would you consider non-core, applicable for sale, and then also given your comments about cap rates, would you look to sell core assets just given the aggressive pricing and the expectation that cap rates may rise over the next 12 to 24 months?

5% I would say non-core at this time. And of course, that definition changes over time as markets change and assets age, and different things happen. So I would say we are down to certainly well under 5%. Maybe as low as 3%. So it's getting down there.

With respect to the sale of assets that are core to our strategy, we do sell a lot of those too, from time to time. For example, there are other parameters. For example, people pay a lot of money for long-term net lease deals, and we've been selling a lot of those because our view of value and the market's view of value are different. So we would be a seller of that sort of thing.

We have value-added conversions in the Bay Area -- the Bay Area's on fire. I mean people are buying our 30, 40-year-old R&D building for high rise office site at 4X the value that we ascribe to them and you ascribe to them in your NAV. We'll sell those. There are user opportunities that knock on our door, that the guy's just got to have our building, and it's a strategic building, so we'll sell those.

But at market, we're not really a seller of normal good operating real estate, because by the time you look at the cost of selling it, the time to redeploy it, you redeploy the money, there's got to be a 5% or 10% premium before you come out even, and that's -- the market is not quite that frothy yet. But if we see a bigger spread than that, of course we're a seller.

That was the last question. Yes. So thank you for joining our call. I know you've got a lot more to go to. We kept this under an hour, and look forward to talking to you next year.

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