Prologis Inc (PLD) 2015 Q2 法說會逐字稿

Good morning. My name is Kyle and I'll be your conference operator today. At this time of it like to welcome everyone to the Prologis second-quarter earnings conference call.

(Operator Instructions)

Thank you. I'd now like to turn the call over to Ms. Tracy Ward, Senior Vice President of Investor Relations. Ma'am, you may begin your conference.

Thanks, Kyle, and good morning everyone. Welcome to our second-quarter 2015 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, 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 conference call will contain forward-looking statements under federal securities laws. These statements are based on current expectations, estimates and projections about the market and the industry in which Prologis operates as well as management's beliefs and assumptions.

Forward-looking statements are not guarantees of performance and actual operating results may be affected by a variety of factors. For a list of those factors please refer to the forward-looking statements notice in our 10-K or SEC filings.

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

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

Thanks, Tracy, and good morning everyone. We just finished a great quarter and our financial results reflect very favorable market conditions and solid execution by the Prologis team. In fact this year is shaping up to be one of the strongest in my 35 years in the business.

We're halfway through the three-year plan we outlined for you at our Analyst Day in September 2013. Let me take a few moments to highlight our key accomplishments since that date.

Capitalizing on the imminent rental recovery was the most important objective among our three key priorities as outlined in the plan. Our market rent growth forecast of 20% to 25% between 2013 and 2017 was viewed as quite bold at that time, yet with the Americas and Asia slightly ahead of forecast and Europe slightly behind the rent recovery cycle is unfolding pretty much as we expected leading to substantial growth in our earnings. This strong rental recovery has been particularly pronounced in the US where the increases are becoming evident in our rent rolls and financial results.

Our investment strategy with its focus on global markets has enabled us to achieve rent increases of 22% with our share of same-store NOI exceeding 7% in the second quarter. New supply in the US continues to be absorbed at a rapid pace driving vacancy down to 15-year lows. Our forecast calls for declining vacancy rates in the US through the end of 2016 with supply and demand reaching equilibrium in 2017.

As the largest owner in the sector we're constantly on the lookout for signs of overbuilding as we have a vested interest in preventing oversupply in our markets. We'll not be shy about sounding the alarm bell at the first sign of undisciplined development. Don't be surprised if our future spec starts remain flat or even moderate compared to starts this year.

In Europe improved customer sentiment is leading to growth in occupancies and rents especially in the UK and Northern Europe. Markets in Central and Eastern Europe are also on the mend, albeit at a slower rate. Even Southern Europe which has lagged the other regions is showing modest improvement.

The big story in Europe, however, is continued cap rate compression which began about two years ago. The rates on the continent have tightened by about 150 basis points since 2013 and we expect them to drop another 50 to 75 basis points over the next 12 months. In addition, appraisals in Europe continue to lag real-time transactions by about 50 basis points.

Turning to Asia, rents in Japan are growing at a healthy pace and vacancies are low. Competition, however, is heating up, putting pressure on land prices and development margins. In China procuring land in the top-tier markets remains a challenge but high quality product continues to lease in line with pro forma.

Our second key priority was to put our land bank to work to realize its embedded value while meeting the needs of our customers. Midway through our three-year plan we've generated $540 million in value creation or about $1 per share in NAV on $1.9 billion of stabilizations.

At full buildout, our land bank can support more than $10 billion of additional development or about four years of activity at our current pace. Our development margins will remain elevated and our closure rate on build-to-suits is running very high. We'll remain disciplined with our development starts and expect to create about $400 million, or $0.75 a share of incremental NAV annually through our development activity.

Our third priority was to use our scale to grow earnings with minimal incremental overhead. At this point in the cycle asset growth is likely to come through development and less from pure acquisitions, unless of course we are able to capitalize on a competitive advantage in a given situation, for example through the use of appropriately priced OP units.

The KTR transaction is an excellent example of these principles in action. It's rare to have the opportunity to deliver significant immediate accretion to shareholders by acquiring a portfolio of such quality which is so consistent with our own.

The KTR transaction reduced our G&A to AUM ratio by more than 15% to 54 basis points. The continued buildout of our land bank will make us even more efficient as we scale our portfolio organically.

Turning to capital flows, globally we see considerable investor demand for high quality industrial real estate. In the US we now see stabilized cap rates in the mid to high 4% range in our best global markets. As I've mentioned before in Europe cap rates continue to fall as demonstrated by our fund valuations where cap rates compressed by another 30 basis points in the quarter.

Before handing the call over to Tom I'd like to leave you with a couple of thoughts. The benefits of scale are clear and manifest themselves in important ways such as lower G&A costs, lower financing rates, a wider array of financing options and a higher share of wallet from key customers. However, size alone does not make us better.

We are better only when we deliver profitably on our objectives. Over the past several years we've taken great care to position our portfolio to where it is today and we're confident that our efforts will pay off in terms of superior same-store NOI growth in the coming years.

Factoring in core FFO growth in 2014 and the midpoint of our 2015 guidance we'll have averaged 15.5% annual FFO growth over this two-year period. AFFO is growing at even a faster rate, requiring us to increase our dividends three times over the past 18 months for a cumulative increase of 43%. With two years of results in, we've already surpassed what was considered to be an ambitious three-year plan as presented on that Analyst Day.

With that I'll turn it over to Tom who will take you through the numbers and guidance.

Thanks Hamid. We had an outstanding second quarter and strong first half of 2015.

Before I begin with our results I want to remind you that we completed the acquisition of KTR on May 29. The properties were acquired by USLV, our joint venture with Norges. You'll see the impact run throughout our financial statements since we consolidate this venture.

The portfolio is fully integrated. The assets have been successfully onboarded and the day-to-day management of the properties has been transitioned to our regional teams, a terrific example of our ability to scale efficiently.

Now let's start with results for the quarter. Core FFO was $0.52 a share, up 8% over Q2 in 2014. For the first half of the year core FFO was $1.01 per share, up 11% over the first half of last year.

Based on feedback we've received from investors and analysts as well as that our share of operations and deployment drives our earnings this will be the focus of our disclosures going forward. We will, however, continue to provide owned and managed information in our quarterly supplemental.

Quarter-end occupancy excluding the KTR assets was 95.6%, up 100 basis points over the second quarter of last year. The KTR portfolio was 89% occupied at the time we announced the acquisition. The operations team is making great progress leasing this portfolio which was 92% leased at the end of the quarter.

GAAP rent change on rollover was 16.6% and the highest quarterly level we recorded to date. Rent change was positive across all regions and led by the US at 22.2%. GAAP same-store NOI increased 5.9% in the quarter and was led by the US at 7.1%.

Now moving to capital deployment for the quarter which again is on an R share basis we continued to deliver very profitable developments. Development stabilizations were $578 million with an estimated margin of over 31% and value creation of $179 million, or $0.34 a share. Development starts totaled $799 million with an estimated margin of 19.6%.

Acquisitions were driven by KTR and totaled $3.2 billion at a stabilized cap rate of 5.5%. Contributions and building dispositions totaled $415 million with a stabilized cap rate of 5.9%.

Turning to capital markets, we continue to tap the foreign debt markets at very attractive terms. We completed $3.1 billion of financing activity in the quarter at a weighted average interest rate of 1.6% and term of almost five years. This included $1.6 billion which was denominated in euro and yen.

Leverage at quarter-end was 40.2% on a gross book value basis and 39.2% on total market capitalization basis which is how most REITs disclosed leverage. Debt to adjusted EBITDA and fixed charge coverage excluding realized gains was 7.6 and 3.7 times for the quarter respectively. We have approximately $1.3 billion of short-term financing related to KTR consisting of the $1 billion term loan due in 2017 and the remainder on our line.

Our plan is to repay this balance through asset sales and I'll get into the specifics of that in a moment. We continue to maintain significant liquidity subsequent to the closing of the KTR acquisition with over $2.4 billion at quarter-end, plus we have no unsecured debt maturities until 2017.

Now let's turn to our outlook and guidance for the year. For operations we're maintaining our year-end occupancy range of between 95.5% and 96.5% and continue to expect development stabilizations for 2015 of $1.7 billion to $1.9 billion. We're establishing guidance for our share of GAAP same-store NOI to range between 5% and 5.5%.

Looking forward the majority of our same-store NOI growth will be driven by capturing the current spread between in place and market rents as leases roll. To put this into perspective, even with no further market rent growth our share of same-store NOI in 2016 should grow at about 4% from just capturing today's rent spread. Our assumption, however, is that market rents will continue to grow.

We continue to expect net G&A for 2015 to range between $235 million and $245 million. On the strategic capital front we've increased our expected revenue range to between $200 million and $210 million. Also included in our guidance is an expected net promote from our PELP venture in the fourth quarter of 2015 of about $0.04.

In terms of capital deployment I'll refer you to our supplemental page 8 for detail on our updated guidance ranges and our share of each activity. You'll note the most significant change is the increase in disposition guidance as well as we believe this is a great time to sell non-strategic assets that we have value maximized.

At the midpoint our share of the expected net deployment for the second half of 2015 is about $350 million proceeds. But I need to point out that the Morris industrial transaction is included in our acquisition guidance which we will fund with approximately 400 million OP units. Therefore the total cash net deployment proceeds for the second half will be approximately $750 million.

Now let me spend a minute discussing the plan to permanently capitalize KTR and focus on three aspects. First, we will retire the short-term KTR borrowings of $1.3 billion through a combination of dispositions and contributions primarily in the US and Europe. With the proceeds generated in the back half this year we will repay approximately 60% of this balance and take our leverage to roughly 37%.

We'll complete the remainder of the plan in the first half of next year to fully retire the KTR borrowings and fund our development needs. At that point our leverage would be in the mid-30s, in line with our target credit metrics and on a path to an A rating.

Second, this plan does not assume any selldown of our fund interest. The reason we have prioritized dispositions in this plan is because we expect substantial increases in European valuations over the next year. Since the downturn we have opportunistically acquired additional interest in many of our ventures, particularly in Europe.

As a result we are well above our long-term ownership target of 20% and giving us significant financial capacity. For example, reducing our interest to this level in our ventures would generate upwards of $3 billion of capital at today's values providing substantial embedded liquidity, optionality and capacity to fund our capital needs beyond the conclusion of this plan.

Third, given our confidence in this plan and the embedded capacity within these ventures we have no need to issue equity as it would generate excess liquidity based on our current deployment outlook and is also consistent with our view of attaining an A rating.

Putting our guidance altogether we're increasing the midpoint of our 2015 core FFO which we now expect to range between $2.18 and $2.22 per share. This represents 17% year-over-year growth or an increase of $0.32 at the midpoint of our guidance which follows 14% growth last year.

As Hamid mentioned our AFFO has grown faster than our core FFO in 2015 and as a result we announced an increase in our third-quarter dividend to $0.40 a share. In closing we had a great quarter and our outlook for our business is equally as strong.

With that I'll turn the call over to the operator for questions.

(Operator Instructions) Steve Sakwa, Evercore ISI.

Thanks, good morning. Tom, I was just wondering if you could provide a little more clarity on I guess the cap rates that you might expect a range of cap rates from the asset sales to fund the KTR deal? I'm just trying to think about maybe what the negative arbitrage would be between what you bought KTR for and the cap rates on dispositions.

The cap rates are going to be on average, again you need to think about this is just being not only dispositions but contributions. I think overall you're going to see those be in the mid to high -- the low 5s on contributions all the way up to the maybe the mid to high 6s on some dispositions when you blend that that altogether. One thing you need to take into consideration, though, is when we contribute assets for funds we also get incremental fees which certainly offsets the dilution.

The other thing is, Steve, there are some land sales as well in that and of course the cap rate on land sales is zero. So I think it will end up being in the mid to high 5s when you blend it all together.

George Auerbach, Credit Suisse.

Thanks, good morning. Tom, with KTR closed can you now talk more specifically about which portfolios or the overall size of the assets that you have in the market for sale in the US and Europe to fund KTR? And in addition can you just clarify your comments on PELP, the selldown. It sounded to me like from your comments that we should no longer expect a selldown of PELP this year.

That's correct. So to be clear our plan is not -- our plan to permanently finance the KTR outstanding balance of $1.3 billion assumes no selldown in our European ventures.

And again as I mentioned the reason we're focusing on dispositions and contributions for this plan is because we expect substantial cap rate compression in Europe over the next year. And as we look at how we're value maximizing assets on sale we're prioritizing dispositions and contributions.

The other thing I would add to that is actually selling in our funds would be the easiest execution that we have out there. Because really all we got to do is look at the NAV at the end of the quarter based on appraisals and make a phone call essentially to get that done. So there is very little execution risk on that.

It's just as I mentioned to you there is a lag in cap rates, from reality there is about a 50 basis points of lag between appraised cap rates and reality in the marketplace and we think the reality of the marketplace is poised for further compression. So yes, we could go do the easy thing and put this thing to bed tomorrow but we'd be leaving about 100 basis points of value on the table and we have lots of other ways of getting to the same place.

But we have this as a plan B with $3 billion of cushion. So we're not losing a lot of sleep over this.

This is Mike. In terms of the geographic distribution of the portfolios, what we currently have in the marketplace or will have very shortly out there it's a good spread of about a dozen markets, some global markets as well as some regional markets.

I think it's a good mix of product that will be attractive to what we're seeing is a very large buyer pool out there. And in terms of pricing we have high expectations given the outstanding cap rates we're seeing now in the US. It's a really good time to put incremental portfolios out in the market and we're bullish on our ability to get that done by year-end.

Craig Mailman, KeyBanc.

I just want to follow-up on the disposition theme here. Looking at where you guys are trading relative to private market cap rates, just thoughts on ramping the disposition program even further to potentially buy back stock.

Well, one thing at a time. I mean first, our dispositions I want to emphasize that the plan, the disposition plan actually has nothing to do with KTR. We would have sold these very same properties as the final step in the cleanup of our portfolio to align it with our strategy, just like the properties we sold in 2011, 2012 and 2013 and 2014.

So it's just basic basically the last phase of that. So KTR, other than a few properties out of KTR itself, does not really impact our disposition plan. It's business as usual.

It happens to coincide with paying off the financing that we took on in connection with KTR but that's just coincidental. So that's the way we're looking at financing our business and any of you guys have anything else to add to that?

Vance Edelson, Morgan Stanley.

Thank you. You mentioned that the development margin should remain elevated. Could you comment on development yields by market first across the US?

We've heard there are some cities where it could be as low as 4%, others more like 6% or higher. And then if you could also provide the international color on the build yields as well. Thanks.

Gene will address that question. I did not address one part of Craig's question which is on stock buyback.

Look, we're going to continue to execute on our disposition plan and also the fund selldowns to align with what our long-term ownership plans are in those funds. Obviously we'll be in a substantially liquid position. We'll be a lot more liquid than what we need to achieve our A rating.

And that capital is available for all kinds of purposes, including potentially stock buybacks but we are nine months to a year away from that because that would be the last thing we would execute on. So it depends on where the stock sits at that point in time and right now we think our priority should be selling our non-strategic assets and paying off the financing associated with KTR. And the stock buybacks are something that will come later and we'll have the capacity to do a lot of that obviously.

So this whole issue of equity issuance which is everybody keeps worrying about and talking about honestly we don't get it because the problem we're trying to solve is excess liquidity not a lack of liquidity. Gene, do you want to start?

Yes, with respect to the development margin, so the US will be high teens and we've said we're going to remain elevated in margins I would say at least over the next 12 months that I could see.

In terms of where those actual returns on cost are they really range from the mid to high 5s. In LA for example if you were to do a build-to-suit in a 4.5 cap rate environment it could be that low and they range into the mid-7s depending on US markets. If you look at Mexico you're going to be in the low to mid 8s and then of course in Brazil you're going to be in the 10% to 13% in terms of return on cost.

Our development yields in Europe, Continental Europe I'd say 7%, 7.5% something like that. In the UK probably in the 5% to 6% range depending on the market. Obviously if you're in the London market it's going to be lower than if you're up in the Midlands.

In China I'd say they're close to the same as Continental Europe probably in that 7%, 7.5% range and in Japan obviously lower than that 5% to 6%. But again we expect yield to be pretty healthy for the foreseeable future. Cap rates are compressing in Europe and values are strong in Asia.

And our land bank is still books substantially less than fair value.

Brendan Maiorana, Wells Fargo.

Thanks, good morning. I wanted to ask about the dividend raise.

Your AFFO, Hamid, I think you mentioned has grown pretty nicely, grown faster than FFO and probably somewhere around $1.80 or $1.85 share annually. So you've got nice coverage relative to the dividend but you guys do capitalize G&A into development, so that doesn't hit the P&L and then you capitalize some interest expense as well.

And we're at a good point in the business cycle. But if development slows down and you start to expense some of those costs that are capitalized do you still feel like you'd have solid coverage of the dividend at $1.60 relative to an AFFO number if you had to expense a few more of those items?

Hey, Brendan, this is Tom. So absolutely. We have very strong coverage when you look at where our payout ratios are.

We look at this with realized gains because that's TI and that's got to go out the door or a proportion of it does. So we're in the low 60% payout ratio if you want to exclude realized gains which we don't look at but we would be in the mid to high 80s, exactly where we've been long term after this dividend raise.

So we feel good about our coverage. We actually need to raise our dividend, not only -- we're not trying to just meet our payout ratios or our targets. We're really trying to make sure we're paying out the statutory minimum.

So we've got TI pressure that we need to increase continue to increase the dividend to make sure we're getting the right amount of TI dividends out the door. Now in your question about capitalized cost to put it in perspective we'll capitalize about $70 million of development overhead this year and maybe $65 million of capped interest.

So when you look at that $70 million against the midpoint of starts for $2.6 billion that's about 2.6% or 2.7%. So it's a fairly conservative capitalization ratio when you think about what is actually out in the marketplace. So even if you would cut those capitalized costs by $10 million or $20 million which I think would be a pretty substantial cut that would have a very minimal impact on our FFO given the nominal amount of AFFO that we have out there.

So bottom line we feel really good about our coverage. And in that scenario I don't think it would materially cover materially impact our dividend payout ratio, particularly as we look at our growth prospects going forward from rents rolling to market.

Hey, Brendan, can I give you one little other piece of color. We've got a big advantage in that we're a global developer and we've talked about this in the past.

Look at the spread of our development activity. It is very broad and you know there's one building per market. We're building in each one of the geographies, $2.5 billion of development spend is not a big deal for us.

We can certainly do more but we have the advantage of literally picking the markets that we want to develop in. So I think a $2.5 billion run rate is a pretty safe rate.

Eric Frankel, Green Street Advisors.

Thank you. I wanted to touch upon the operating portfolio a little bit. First, I'm not sure, do you ever mention what your cash releasing spreads were by market? And second, regarding releasing spreads which markets benefited the most? Were there global markets, were there more of the regional markets or just like to get a little bit of more color on that. Thank you.

Eric, I'll take the cash rent change on rollover question. So I did not mention it but the cash rent change on rollover was about 4.5% for the quarter as compared to the GAAP rent change.

Now that is spread a little wider than what we've had in the past. But what's happening is given the significant spread between market and rolling rents, our customers are asking for help to mitigate really the sticker shock that's happening with the significant rise in market rates just look at this quarter alone. In the US we saw 22% increase in spot rates to rolling rates.

And as a result we're trying to help customers ease into these higher rents with escalations, really just in the initial part of the lease. So that's why it's really important to look at the net effect of rents calculation because that captures the economics of the overall lease.

Looking at a cash rent change you pick up just that spot change from the last lease to the initial lease which clearly doesn't represent the economics of what you're signing up for. So we focus on the GAAP net effective.

John Guinee, Stifel.

Great, thank you. Here's my question, I'm trying to get to the bottom of it, is you've got great same-store NOI growth.

You've got excellent mark to market. You have a good value creation and development pipeline.

But if I look at PLD at a 5% fixed cap rate, your per share in 2013 was $46.80 and your per share [FFO] cap for 2015 is $47.70 which is less than a dollar of value creation from 2013 to 2015. So I can't quite see where the leakage is and do you guys have any explanation for that?

I'm not sure how that math works, John. The NOI number is growing if you're taking the same cap rate and applying it. Actually interest rates are increasing so the mark to market on the debt should be getting smaller and we're creating $400 million of NAV through the development process every year.

So I've got to look at the detailed math of what you're talking about but I'm not sure I totally understand it. There is some degree of FX factored into that but again most of that is mitigated because of the fact that we have matched liabilities with our assets overseas. So I can't do that math for you right now but we'd be happy to take you through that analysis.

By our estimation our NAV should grow by about $1 a share, a little less than $1 issue through the development activity. And in the foreseeable future we see earnings growth in the low double-digit range and probably even 10% just to pick an easy number.

So that would be $3 or $4 of NAV growth. So I don't know what you're doing with your math but happy to take a look at it.

Am I still on the line?

You are.

This math just comes from page 34 to 36 from your NAV. This is not anything I'm doing creatively or uniquely. I'm just tracking your NAV as presented in your supplemental every quarter for the last three or four years.

Well the other piece of it, John, would be the cap rate that you're assuming as well on that NOI.

Yes, there's definitely been cap rate compression over the last 12 months for sure. And I don't know if you're using a constant cap rate or what you're doing.

Brad Burke, Goldman Sachs.

Good morning guys. I wanted to ask about your leverage mix.

Obviously you're able to issue a lot of debt this quarter at a very low rate. Just want to get an update on how you're thinking about the mix of floating rate in non-US dollar-denominated debt versus where you're at today.

Hey, Brad, this is Tom. So today we're at about in the high teens on variable rate debt. Prior to the KTR funding we were in the high single digits.

We're going to get back to that high single-digit range once we complete the permanent funding plan and with selling dispositions and contributions that will fund this. So we'll get back down to that range. Our bias is to go long and to fix as much interest as we can at this, just given where rates are.

Regarding the mix of foreign-currency debt versus US dollar debt, based on where our US dollar net equity is we're at about 90.6% at the end of this quarter. Once we complete the KTR plan we're going to be pushing more of the middle, middle 90s of US dollar net equity so we don't have really any room today to move up our proportionate of foreign dollar debt. Going forward we will do our best to match fund our foreign denominated asset growth with foreign denominated debt.

Dave Rodgers, Baird.

Yes, good morning, guys. Maybe for Mike a question on construction cost. Can you talk about what you're seeing in terms of the construction cost components increasing? And maybe a second part to that is how do you see construction costs keeping pace with rent growth here, particularly in the US in the near-term?

Dave, in terms of construction costs, we're seeing there has been increases in the US over the last couple of years in the 3% to 4% range, perhaps as high as 5% in select markets where competition is more intense. For the most part in the global markets, we're seeing rents outpace that. That's why you're seeing some construction that you are from a supply standpoint.

Going forward, we anticipate that moderating a bit, maybe into the 2% or 3% range. But I think there's still some pretty significant competition for construction services, given the heavy load of development activity that's out there.

And in Europe, I'd just say we haven't really seen significant construction cost increases because there isn't a lot of development going on today, maybe just a bit. China, we're seeing some small increases as supply continues to move forward.

Japan is the interesting one. Japan, we had a spike right when the 2020 Olympics were announced and then it peaked, and it basically stopped. We think that as you get closer to the 2020 Olympics, you're going to see construction cost increases in Japan.

At the same time today, we're seeing land increases, very significant land increases in Japan. So I think that underpins a pretty healthy story for rent growth in Japan over the next several years.

And land is increasing pretty much across the board in the US, along with entitlement cost. So while construction increases have been moderate, we think they're going to outpace inflation. Overall replacement costs are going up pretty rapidly.

Vin Chao, Deutsche Bank.

Hey, good morning, everyone. I just want to go back to the rent spreads here which were quite strong in the quarter, accelerated from the first quarter. But I think when they were talked about originally, there was some negative mix in the first half, more European leasing than in the second half. Just curious if that maybe didn't play out the way you thought and that was part of the reason why we saw such strength in the first-half spreads or if that's still going to be a positive tailwind to you in the back half and if you could maybe quantify that how that mix is changing?

Vin, this is Tom, we've really normalized the mix starting in Q2. Q1 we were and part of last year as you point out we were more heavily weighted towards Europe and particularly Southern Europe and Central and Eastern Europe, so it's moderated.

So that would be one thing. And then second would be just the strength of the US markets and the proportion of leasing with the US markets driving these returns.

So going forward I think we'll expect. I don't foresee any real mix issues like we had in the past with Europe or the US being disproportionately different.

Manny Korchman, Citi.

Hey guys, good morning. If we could just go back to your earlier comment on cap rates compressing in Europe and your hesitation to sell there at the moment, can you balance that against A, your acquisition plans for the rest of the year maybe into next year and how much of that will be in Europe and B, how you get comfort buying in the US and selling in the US at the same time?

Well, from a mix standpoint if you look at our acquisitions this year it's very much you really need to look at the remainder of the year. It is weighted towards the US and the Morris industrial transaction which we agreed upon pricing there probably six to nine months ago. So from that standpoint we are focusing on -- that's a big driver of the US as well as we do have some US 1031 activity going forward.

When it looks about balancing buying in the US versus Europe we're always looking at the relative returns and the overall growth profile of what we're buying and what we're selling. And looking at the KTR portfolio in particular very high quality portfolio that we expect to perform right in line with the rest of our US portfolio.

Look at how our US portfolio is performing right now. We expect the KTR portfolio similar quality to perform equally as well. I think that is a big testament to why we wanted to buy that portfolio.

The only comments I'd make with respect to Europe is as Tom said in his prepared remarks we've obviously increased our ownership position in our funds, that's the best acquisition that we can make. Over the last several years we've been buying portfolios and as we've told you there while we'd like to buy more in Europe there aren't a lot of portfolios to buy. So we're focusing our time on those one-off acquisitions and those value-add deals.

And you can see it coming through in our numbers. We did two building acquisitions, one in Prague and one in the Netherlands in the second quarter at a total of $144 million year to date. If we could get more in Europe and it was good quality stuff we would do that.

At the same time we will be selling non-strategic assets in Europe when we feel like they're value maximized. So we are going to be both buyer and seller in a market like this.

And rounding out the activity in the US the majority of it outside of the large portfolios of Morris and KTR are the value-add acquisitions in the US as well where our local teams identify those. Those aren't subject to the same pricing pressures in general that we see on the larger portfolios and it's a way we keep our acquisition activity strong in the US on more of a case-by-case, project-by-project basis.

Ki Bin Kim, SunTrust Robinson.

Thank you. So Hamid, maybe we can go back to the earlier conversation regarding capital deployment and KTR. And I think I heard you correctly when you said that you didn't fully understand the market's reaction to equity overhang risk, some of the things that you've heard from the buy side.

If you could reflect on just what has happened in the past four months or so with the KTR deal, what are some of the things that you possibly learned or maybe you could have done differently maybe a forward equity issuance or maybe just a whole host of things that you could have done differently or not. I was just curious what your reflections are regarding that and how your stock price reacted post the deal and what feedback you received from investors?

Okay, that's a really good question. The thing that I learned is that you can be totally honest with people in the way you present something and in the interest of being super honest and straightforward with people you could convey an impression that could be really inaccurate.

So let me elaborate. Every M&A deal that a company does they talk about its accretion using the capital structure that will be deployed immediately to fund that acquisition which in our case is 1.5% debt. And we should have come out maybe and said this deal is not only NAV neutral because we're buying it at market but it is accretive to the tune of 15% or some crazy number like that because we're financing it on the margin with 1.5% debt.

And that would have been the least if you will honest thing honest way we could have portrayed it so we elected not to do that. We used the words, this is how accretive it is on a leverage neutral basis. And I think the market read that as we are immediately going to finance this on a leverage neutral basis and I think it created an overhang.

Remember we own a lot of the stock. We're not selling our stock at a 10% discount or now 20% discount to real estate value just to buy fully priced real estate.

We get that math. Come on guys. We've been doing this for a while.

So clearly that is not what we intended to do. We know all the sources that we have, we know how much non-strategic assets we have that we're going to have to sell anyway whether we do KTR or not.

Sure we have to sell a few more with KTR because as we mentioned to you about 5% of KTR is long-term non-strategic. So we're going to sell our non-strategic assets and that happens to fully fund this transaction over a 12-month period.

And to us that's very comfortable. We are committed to our single A rating but that doesn't mean we need to achieve it tomorrow. We're heading in that direction.

We're not telling a different story to the rating agencies that we're telling to the equity holders. All of what we've told you has been consistent and in my belief presented in the most responsible way possible. But I think it -- the issue about the leverage neutral language and talking about the timing that was assumed that we're going to get this in balance right this second after it closes, I think were actually misinterpreted by the market and we'll take the responsibility for that miscommunication.

But the reality is we'll fully fund this transaction within a year. Our leverage ratios will be back in line, consistent with that single A rating and above and beyond this we've got about $3 billion of in effect equity firepower sitting in our funds that once those funds and ventures are valued properly, particularly in Europe because of continued cap rate compression and closure of that appraisal lag we'll take advantage of those in a way that it matches it with our needs with our capital need so we don't have a big capital drag on our income statement. I hope that clarifies it.

Ross Nussbaum, UBS.

Hi, thanks. Hamid, you had commented that we shouldn't be surprised if the development pipeline stabilizes or goes down as we look out over the next few years.

I'm going to assume that we should also expect the same from the land bank but perhaps you could comment a little more, is there any expectation the market should have that the land bank could really move down beyond what happens to the development pipeline just so that you get more of these non-income-producing assets off your books so that your earnings multiple isn't negatively impacted by that?

Sure, that's a really good question. You know to be perfectly candid with you not all of our land is strategic. In fact, we've qualified, classified about $400 million of our land as non-strategic meaning that we don't intend to develop it.

Either somebody else is going to develop it or we'll sell it to the user or something like that. So of our book value of land bank that you see today, you know $400 million of it should not be there and we're going to sell that no matter what and not replace it with anything else.

So the land bank for sure would come down. Then in a normal market we will be acquiring land at the same rate as we'll be putting land into production. We'll reach some level of equilibrium at some point.

Our best guess is that in that situation we would have $1.2 billion, $1.3 billion of land which is about two years of development at a run rate of $2.5 billion and the math on that is pretty simple. Two years of $2.5 billion development is $5 billion and land is about 25% of the total. So that gets you to about $1.250 billion of land that we need to carry around here.

And so if you want to be in the development business and generate whatever we generated, I think it was 17 unleveraged IRRs over a period of 15 years, you've got to have land. The unfortunate thing as you all know in our business we don't get to count that as earnings and that's fine because I think when the industry counted that as earnings bad things happen. So we're good.

But it's real money, it's real cash that comes in the bank in the Company and it's real NAV that's created. And we can be patient to realize that value. So the bottom line is we like the development business.

You have to have some land to account for it to be able to play in that business. It's the highest rate of return business we have but we have too much land in relation to our development volume going forward.

As to my comment that we're going to moderate it is that, look, four years ago, five years ago before there was a development business in the depth of the crisis we told all of you that our annual development volume is going to normalize from $2 billion to $3 billion a year globally. And in some markets and sometimes it's going to get closer to $3 billion and sometimes it's going to get closer to $2 billion.

I guess what I'm saying is that it's been going steadily up in the last three or four years and now it's about $2.6 billion, $2.7 billion. Don't be surprised if that comes down to $2.4 billion, $2.5 billion or something like that. That's very normal and we're going to bounce around numbers like that going forward.

Jamie Feldman, Bank of America.

Great, thank you. I'm here with Jeff Spector as well.

Can you just talk a little bit about the KTR yields and how they came in or how they are coming in versus your original expectations? I think on the first-quarter call you guys had said the in place was a 5.2 cash, this stabilized was a 5.5 and if you backed out the CIP in land it's a 4.85.

And along the same lines if you look at there was an occupancy dip across the portfolio in the second quarter, can you talk about how much of that was KTR versus the rest of your portfolio and what gives you comfort on getting to the guidance you've laid out which is at least a 10 basis point growth if not more?

So Jamie, it's Gene. I think KTR had a 20 basis point effect globally. But let me get to your yield.

So things are playing out as expected. If anything the rents we're getting on new leases and by the way we signed about 40 leases since we've announced this transaction, about 2.5 million square feet in that portfolio. But we're right at a 5.5 yield on a stabilized basis so this is the same way we describe any acquisition.

So that's 95% occupancy. At 89% you're correct it was around a 5.2 but we're already at 92% leased in this portfolio and our plan is to be just under 95% by the end of the year. So we're a little ahead of schedule relative to the 12-months timeframe that we outlined to get KTR in line with the rest of the US portfolio or said another way around 96%.

So hopefully that clears up the yield. I see upsides in the yields because the rents are coming in a little better than we expected.

Jamie, on your point about the 4.9% cap rate I think you meant to say that if you include the land and the CIP in addition to the operating assets the yield would be 4.9%.

Craig Mailman, KeyBanc.

Hey, just a -- can you hear me?

Go ahead, Craig.

Hey, it's Jordan Sadler here with Craig. Just a clarification. Can you are you saying that and I think I understand the sentiment but there's no equity in the plan any longer.

I think last call and where some of the confusion came in was Tom, you gave the example on a leverage neutral basis talking about the issuance of potentially $1.5 billion of equity. So obviously there's some communication about that ultimate financing which I know I now understand was not imminent necessarily in terms of how you were trying to communicate it. But now you're saying the plan just does not assume equity, this is going to be done through asset sales.

If I may take that question because it's my bad more than the Company's or Tom's I think we laid out alternative financing plans for you. I think we laid out three financing plans and one of them included equity and two of them did not include equity and we wanted to be -- we wanted to give you the bookends of what could happen in terms of financing this deal.

Our current plan and the one that we're executing right now assumes no equity. The only equity that exists is in effect the OP units that are part of the Morris transaction that go with the Morris acquisition. If you want to really define equity in a broad way and just by way of reminder, the valuation of that equity is fixed at where our NAV was on whatever we negotiated that deal about a year ago.

It's $43.11, which by the way after discount, issuance discounts and all that is equivalent of $45 a share. So that's the only equity that's ever been in the plan before or after KTR and there's none contemplated in the current plan.

John Guinee, Stifel.

Yes, on a lighter note going back to Europe I've been watching the Tour de France almost every night and I have yet to see a PLD roof or a PLD sponsor on any of the teams. Are you guys doing that this year over there? (multiple speakers)

It's too expensive, John. It's too expensive to get your name on that those jerseys as you know. So we're going to keep our money for dividend growth. But --

You may see something on the roofs, though.

So John, you asked a good question and Tim Arndt, our Treasurer, has been actually trying to reconcile the numbers for you. So instead of waiting I think he's prepared to talk about it right now. So let's answer your last question now.

Yes, hey, John. I'm guessing I think between the two periods you described you're seeing if we look at I believe you're holding cap rates constant, understand that.

The NOI growth is flowing through, you're probably seeing an addition of something like $3 to $4 a share on that basis. And I'm guessing you're also seeing something on the order of $1.50 a share in terms of development value creation added over that period.

I think the components you're missing are we had about $1 come through the way we present our NAV in the supplemental, what would appear to be loss from debt extinguishment which is a temporary phenomena. We bear those debt premiums initially and we earn them back in a period of about two to three years through lower interest expense subsequently.

So that will be coming back through the NAV statement through about 2018, 2019. The other component that would deserve acknowledgment is it's really 2013 when we got ahead of all of our hedging and debt placement and until that got up and running it's a fact that we probably saw about $1 to $1.50 of NAV loss before that program got completed.

If you looked at what we did in terms of bond financing in the euro market as that market opened up that principally got done in 2014. So you know we're fully hedged now. We won't see any further loss from FX in NAV today and we'll earn the debt extinguishment back in about two to three years.

And John, so that you understand the strategy behind the timing of that euro match funding, the time we did the merger, 40% of Prologis' equity was in foreign currencies, I mean I'm sorry in US dollars. 60% of Prologis equity was in foreign dollars. And to that date we had, certainly I had not ever heard a single call about currency exposure in this Company.

One of our first objectives the day the transaction closed that we said we're going to neutralize and insulate this Company against currency movement. But we couldn't do it immediately because remember PEPR was a big component, we had to bring PEPR in and then recapitalize it with PELP all that stuff until we could get all the puppies in the right pond we couldn't really refinance the transaction.

So as soon as we got these pieces in the right buckets we basically executed on our immunization strategy on FX which is it's really like the debt extinguishment. Basically you had an FX hit up front and you are going to earn it back over time in terms of earnings and matching on the debt side. So if we hadn't done that at that time the launch that Tim just qualified for you for $1.50 would have been in excess of $5 a share.

Eric Frankel, Green Street Advisors.

Thanks for the follow-up questions. Tom, not to beat a dead horse but regarding the releasing spreads could you clarify what the average rent bumps you're at getting on new leases?

Second, regarding disposition plans, how many market exits do you guys plan over the next year or so and then third related to the KTR deal, it looks like New Jersey had the biggest event dip in occupancy, so just want to understand if there's any particular buildings that need to get leased up? Thank you.

Eric, I'll take the first part of that. So our bumps over the life of the lease really aren't changing on a long-term basis. What's really happening is the initial rents in call it the first maybe six months of leases that are getting stepped up.

So instead of walking somebody to market day one the sticker shock that is happening, tenants would like to walk into that say over three months or six months. So that initial rent you're not seeing the full mark-to-market day one but you are going to see it over the next quarter or two.

Eric, let me give you an example and this is real life and during this past quarter we had like a dozen examples like this. So put yourself in a tenant's position you're paying $3 a foot in rent and the market rent today is $5.

That exists all over the United States. That's real sticker shock and we may cut a deal at $5 flat in which case you'd have a 66% cash rent change or we may say all right, we're going to give you $3 for the first year, then its $5, then it's $6.25 for the next two years. That's a 0% cash rent change.

And that second deal has a higher net present value to us. So the problem with this statistic is that in volatile periods on the upward cycle and the downward cycle it doesn't really tell the whole story.

With all due respect and we should stick to real estate which is our business and we will leave analytics to you guys, but in any asset class where the duration of the leases is longer than one year, the concept of cash-to-cash comparison becomes a little problematic. In apartments and hotels or whatever, that concept works just fine because there is no profile to the term of the lease.

But the minute you get into four- or five-year leases you can do all kinds of shapes of leasing with different present value implications that will affect that number but really doesn't affect the effective rent. But we'll continue to report it and I'm sure you'll continue to look at it but honestly in the way we run our business we're not that focused on that number.

Yes, we could also make our teams conform to a policy that would make this look better but I don't want to do that. I want these guys to do smart deals based on what the market gives them.

So your other question was on New Jersey. So we had a 750,000 square-foot development go into the operating pool this quarter and that really is the driver of the occupancy.

With respect to that building we've good activity on it. We're not really worried about it. And New Jersey overall has frankly had quite a bit of construction over the last year.

But that's very much moderated. Not much in the pipeline. So we feel good about that market long term but it's that development that was pulled into the pool that caused that.

And it was a Prologis development, not a KTR development.

Brendan Maiorana, Wells Fargo.

Thanks. A follow-up for Tom. So the property operating margin in the quarter was pretty high.

It was close to 73% which I think is one of the highest that you guys have had in Q2 for the past several years and was up sequentially from Q1 pretty materially even though occupancy levels were down. Just wondering if there was anything unusual that hit this quarter such that the operating margin might be impacted from the run rate from the Q2 level for the back half of the year or as we think about it for 2016?

Nothing unusual that would move that materially. Just given where occupancies are trending very high and where we're seeing, revenues are certainly growing a heck of a lot faster than expenses and occupancy is going up. So our operating leverage is increasing meaningfully and that is what is going to drive that margin.

Sumit Sharma, Morgan Stanley.

Sorry, no questions. They've all been asked. Thanks.

Great. I think that was the last question. Again I want to thank you for participating.

We're really feeling good about our business and we're not taking our eye off the risks that are entailed in our business. So you can rest assured we're vigilant but excited about finally having our day in the sun. Thank you.

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