Prologis Inc (PLD) 2016 Q2 法說會逐字稿

Good afternoon, my name is Kim and I'll be your conference operator today. At this time I would like to welcome everyone to Prologis second-quarter earnings call.

(Operator Instructions)

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

Thanks, Kim and good morning, everyone. Welcome to our second-quarter 2016 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 market environment; Gary Anderson, our CEO of Europe and Asia, who will provide an update on our European and UK businesses; and then from Tom Olinger, our CFO, who will cover results and guidance Also joining us for today's call are Mike Curless, Ed Nekritz, Gene Reilly and Diana Scott.

Before we begin our prepared remarks, I'd like to state that this call will contain forward-looking statements under federal securities laws. These statements are based on current expectations, estimates and projections about the market, and the industry in which Prologis operates, as well as management's beliefs and assumptions. Forward-looking statements are not guarantees of performance and actual operating results may be affected by a variety of factors. For a list of those factors please refer to the forward-looking statement notice in our 10-K or SEC filings.

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

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

Thanks, Tracy, and good morning, everyone. We posted another great quarter with positive room change at almost 18% while maintaining high occupancies. Our core FFO per share grew 15%. Our capital deployment and monetization activities were above expectations as we continue to strengthen our balance sheet.

In our strategic capital business, we have ample fresh commitments from investors and are well positioned to take advantage of any market opportunities that may present themselves. All in all, the last six months have been the best in our Company's history.

We understand, though, that some of you are concerned about our exposure to Europe generally and to the UK specifically. So far, however, the impact of Brexit on our operations has been minimal. Our UK customers served mostly domestic consumers and we believe the decision to leave the EU will not materially change the buying habits of 65 million people.

We're also confident in our overall European business. E-commerce and supply chain reconfiguration continue as big drivers of demand for our product. The class A market is where the action is and where our portfolio is focused.

Any modest decline in GDP growth will, in all likelihood, be offset by the need to carry slightly higher inventories. In fact, our only concern in Europe is in Poland where a few merchant developers are over-building the market by offering rental incentives of up to 40% and convincing new investors to capitalize artificially inflated headline rents. We don't see this anywhere else in Europe.

Surely, there will be more mixed news coming out of Europe and that will lead to continued market volatility. Whether it's bank failures or constitutional reforms in Italy, or elections in France and the Netherlands, we expect policy makers to keep global interest rates lower for longer. In time, this will translate into support for lower cap rates across Europe. We're confident in the resilience of the logistics real estate business but we remain vigilant and on the lookout for any signs of trouble.

Before we turn the call to Tom, Gary Anderson, our CEO of Europe and Asia will share some on-the-ground facts from our business in Europe. You'll hear from him in a moment.

Elsewhere around the globe market conditions remain strong and steady. Overall the supply and demand future is in great shape, with all-time low vacancy rates. Demand is driven by steady growth in consumption, e-commerce, and supply chain modernization.

In the US, rents are up again sharply and we expect net absorption will again exceed new supply for the year. In Japan, new supply from development is being absorbed and cap rates continue to compress, while occupancy and rents are up in China. Even in our softest market, Brazil, we're 100% leased. But rents there are down about 10% from the peak.

Looking across our markets we only see a few locations of excess supply, specifically Houston, Columbus and as I mentioned earlier, parts of Poland. In these lower barrier markets private developers and their institutional capital partners are delivering more product than the market can absorb. Other than these few exceptions, our markets are in very good shape.

In conclusion, we've worked hard to position our Company for success and are excited about the prospect for the coming years. Let me now turn the call over to Gary.

Thanks, Hamid, and good morning. The European market performed very well in the first half of 2016 with demand outpacing supply. Market vacancy in Europe is currently 6%, down 60 basis points year over year, and is currently projected to end the year at 5.8%.

The Prologis portfolio outperformed the market and delivered some of our strongest results on record. Occupancy in our European portfolio is 95.6%, up 130 basis points year over year and 70 basis points quarter over quarter. The UK led all regions at 98.8% occupied, and today the 22.4 million square foot operating pool in the UK is 100% leased. Rent change on roll for the quarter totaled 5.1% in Europe with all regions delivering positive results and was led by the UK at 17.6%.

I'd like to turn now to our activity post Brexit and present simply the facts as we see them on the ground from June 23, the day of the vote, through today. Let's begin with leasing. We've completed 56 transactions in Europe totaling just under 4.9 million square feet, with 8% positive rent change. The UK portion is 1.3 million square feet with 24% rent change during that same post-Brexit period.

Demand in Europe still appears to be broad-based and continues to have an emphasis on the automotive and e-commerce sectors. We've completed leases post Brexit with many names you'll know, including DHL, Schneider Electric, Jaguar Land Rover, Marks & Spencer and Alibaba.

Risk associated with our UK NOI has been minimized. Today the UK portfolio is 100% leased, has a weighted average lease term of eight years, has only 11% of leases expiring over the next 18 months and has in-place rents that are roughly 10% below market.

Let's now turn to Europe development activity. We've had a very prudent approach to development in Europe with a heavy emphasis on build-to-suit. Today we have a 6.2 million square foot development portfolio in Europe which is 60% leased, and is approximately 1,000 basis points ahead of our underwriting. The UK portion of our development portfolio totals 1.9 million square feet and is 850 basis points ahead of our underwriting.

We also expect to execute two leases totaling about 570,000 square feet imminently and have good activity on the balance of our UK developments. The only exception is a 317,000 square foot building in London Gateway where there has been little activity, even before Brexit.

Turning to capital markets and building sales. We sold a three-building portfolio in the UK during the second quarter and that transaction closed as planned on June 21, two days before the referendum vote. We also began negotiating the sale of EUR100 million-plus French portfolio pre-Brexit and concluded discussions on Friday of last week with no change to our pricing. The buyers are now under contract with a 10% non-refundable deposit.

There has also been some non-Prologis activity to report in the UK that underscored solid pricing for logistics assets. A 103,000 square foot building leased to DHL in Birmingham with a 10-year term closed on July 1 at a 4.8% stabilized cap rate. And another 176,000 square foot building led to Amazon for 10 years in Manchester is expected to close at about the same level in the next few days.

In addition, a UK retail fund has brought a GBP50 million British telecom logistics deal to market and has asked that buyers transact in just five working days. There are reportedly more than 10 bidders at about a 5% stabilized cap rate, probably 15 to 20 basis points higher than we would normally expect, but a very small discount when you consider the time scale and lack of due diligence.

Beyond that, we're hearing rumors certain retail funds may bring asset to market to create liquidity and we will monitor those for opportunity. In general, values in the UK are driven by lease length and location. So you shouldn't expect to see any meaningful value change in the Prologis UK portfolio, given our current lease length, location and interest rates that are widely believed to be going lower for longer.

Lastly let's turn to our funds. Values are up 70 basis points this quarter in our European funds on incremental leasing and cap rate compression on the continent. But NAVs are flat to slightly down, given the negative impact of lower interest rates on debt mark-to-market and FX.

While we don't expect so see significant investment activity during the summer months, and as a result we don't expect to see much change in fund values, here is what we can tell you as of today. Our open-end fund, PTELF, has a EUR400 million equity queue, its largest ever. We have closed EUR70 million in new equity commitments in PTELF as planned on June 30, again post Brexit from a Swiss capital source. Our open funds in Europe are approximately 30% levered and our JVs are 0% levered, so we have plenty of capital to take advantage of the right opportunities should they arise.

On June 30, we had one secondary trade occur in our PEP II vehicle. It was a EUR16 million trade at par between a fund that was expiring and an existing PEP II investor. The at-par trade validates our current fund valuations. To date we have had no formal redemption requests but have heard some noise about two sterling investors with investments totaling about EUR45 million that may pursue secondary trades.

So let me quickly summarize. Leasing volume and rents appear to be holding up well. On the development front we are significantly ahead of our underwritten lease-up. New supply is generally in check and we expect to maintain a high build-to-suit percentage this year.

While we can't speak to UK office or retail which have their issues, high-quality logistics assets appear to be trading at valuation. And with respect to Prologis funds we are in great shape with record queues and capacity to take advantage of any opportunities that present themselves.

With that, let me turn it over to Tom to take us through the rest of the quarter.

Thanks, Gary. For the second quarter we generated core FFO of $0.60 per share, exceeding our forecast due to better-than-expected real estate operations and higher asset management fees. Global occupancy was 96.1% for the quarter, up 70 basis points year over year.

We set another quarterly leasing record at 49 million square feet, including more than 9 million square feet of development leasing. Our share of net effective rent change on rollover was 17.8%, led by the US at 23.5%. Our share of same-store NOI increased 6.1% with US leading the way at 7.5%.

This is the last quarter that we'll be impacted by the burn-off of merger lease intangible amortization. Excluding this impact, our share of same-store NOI growth for the quarter would have been 5%.

For the first half of 2016, development stabilizations were $1.1 billion with an estimated weighted average margin of over 26%. Development starts totaled $658 million, with an estimated weighted average margin of over 18%. Build-to-suits comprised almost half of our year-to-date starts.

Dispositions and contributions totaled $1.2 billion. In terms of total capital proceeds, we've already closed or have under hard contract, about 70% of our original full-year guidance.

Turning to capital markets, our leverage at quarter end was 37% on a book basis and 30.6% based on market capitalization. Debt to EBITDA, including gains, was 5.6 times. Our liquidity, which we define as our undrawn line capacity and available consolidated cash, reached the highest level in our history this quarter.

Turning to guidance now for 2016, I'll just cover the material changes. So for complete detail refer to page 5 of our supplemental. Due to stronger operating fundamentals we're increasing our share of same-store NOI range to between 4.75% and 5.25%. In light of our progress year-to-date and investor interest, we're increasing our share of disposition and contribution volume to between $2.3 billion and $2.8 billion, an increase of $300 million at the mid point.

We will complete an additional ownership rebalancing in our US LF and PTELF ventures for a total of $200 million. This is on top of the $400 million we completed earlier this year.

We're also raising the mid point of our share development starts by $200 million for a range of $1.7 billion to $2 billion. We expect our full-year build-to-suit percentage to be higher than the 44% we did last year.

The net results of our deployment changes is that we now expect to generate $1.3 billion of total proceeds in excess of our capital needs, up $300 million from prior guidance. We will use a portion of the net proceeds to retire debt, with the balance further building up our cash reserves. We expect to end the year with liquidity at about $4 billion and book leverage below 35%.

Related to FX, our 2016 and 2017 estimated core earnings are fully hedged relative to the US dollar and we have already hedged about half of 2018. Putting this all together, our 2016 core FFO, excluding promotes, is higher by $0.03 due to better-than-forecasted operations and fees, partially offset by the dilution from an increase and acceleration of the dispositions, contributions and fund rebalancing. In other words, core earnings are higher while at the same time, significantly increasing our cash reserves.

We expect 2016 core FFO, including the promotes, to range between $2.52 and $2.58 per share, maintaining our $2.55 mid point. Our promote range is now $0.14 to $0.16 a share, down $0.03 at the mid point. The decline in the promotes is primarily due to negative debt mark-to-market and FX movements from the pound weakening against the euro. The promote mid point assumes that asset values remain unchanged with June 30 appraisals and FX rates remain at current levels.

To be clear, asset values in Europe have not declined. In fact, the appraised value of our assets in our European ventures increased 70 basis points in the second quarter, led by the UK at 100 basis points.

To wrap up, we expect continued strong NOI growth as we harvest the gap between in-place and market rents. We're maintaining strong double-digit core FFO growth in 2016 while at the same time further strengthening our balance sheet and building liquidity. Our financial position has never been stronger and it will continue to improve by year end, as we generate additional proceeds from net deployment.

With that, I'll turn it over to the operator for your questions.

(Operator Instructions)

Jamie Feldman, Bank of America Merrill Lynch.

Great, thank you.

Tom, if you could -- sticking with the promote, can you talk us through the math of the $0.03? And then, how we should think about the risk to promotes going forward, whether it's this specific one or in the future ones that are maybe scheduled to happen in future years?

Sure, Jamie.

So the $0.03 decline from our mi point, again, was driven by mark-to-market of debt, given the very low interest rates in Europe that happened over the quarter. We saw a hit to our debt mark-to-market. The other impact was FX, as it relates to the sterling and the pound. Clearly as --

Sterling and the euro.

I'm sorry, sterling and the euro, I'm sorry. So when you think about values in sterling as they get converted into euro -- again, the weakening of the pound against the euro caused the decline.

Going forward, the midpoint of the promote range is based on current June 30 valuations. As Gary said, we don't expect any material changes in valuations at all, if anything, over time. Given lower interest rates for longer, we would expect cap rates to go lower. And also the midpoint of the promote range assumes FX rates stay at current levels.

Sumit Sharma, Morgan Stanley.

Hello, good morning.

A question about the development starts. We saw a change, or a shift, in the US side of the composition of the starts Q over Q, and that's expected seasonality-related. But we also saw an increase in building in China as far as the rest of the world is concerned. Could you comment on whether this is a response to lower spec starts, particularly in the UK, and the EU in general?

And as a follow-up to China, what should we expect? Should we expect a continued shift towards Asia going forward, given that the opportunities in one of your strongest UK markets are limited?

Let me take it -- it's Gary.

First of all, we don't try to adjust one place to the other, one geography to the other. We simply take what's given. If there's a good opportunity to develop at a reasonable margin we'll take it.

With respect to China specifically, we're building a business there, really in the four key markets. And we see acceleration in our business on the development side, because it is a development business there, coming in China. So we perhaps should have signaled that we would have seen increasing development starts. It has been building, candidly, over the last several years and I would expect it to continue to build in China to a point. But again, our focus is going to be only on four key markets in China and we'll take what the market gives us.

Jeremy Metz, UBS.

Hey, guys. Maybe one for Tom.

Tom, in the past you've been pretty clear about the longer-term goal here is to get to an A rating. So I was wondering -- prior commentary was that you saw NAV right around plus or minus $50. So given where the stock is today, is there any thought, or did you give any thought, to issuing equity here to help accelerate getting to that A rating versus ramping up the dispositions at this point?

Hey, Jeremy.

Yes, we believe that our balance sheet existing in our prior plan before we updated guidance -- the $1 billion liquidity -- that positioned us as an A-rated Company. Now we're going to further enhance our liquidity, further strengthen our balance sheet this year, have more cash reserves. I am more confident than ever that we have an A-rated balance sheet. So I think we execute against this plan, we will be an A-rated Company.

We're not issuing equity.

Eric Frankel, Green Street Advisors.

Thank you. This is related to the Brexit campaign. Global trade has significantly slowed in the last several years and there's a lot more protectionist rhetoric coming out about politics. So my question is, do you have any thoughts on how this global trade slowdown, whether it's through politics or naturally, how that impacts warehouse demand for your portfolio over time? And have your customers discussed or made contingency plans in regard to some of these events?

Yes, global trade, which used to run at about 3X the sum of domestic GDP, has slowed down to about 1.2, 1.3 times the pace of domestic GDP. It's still growing a little bit faster, but as global trade represents a larger and larger percentage of domestic GDP, the math just drives you there. Because when global trade was only 2% of the total GDP, it had a lot of opportunity to grow. But once its reached the saturation level it's tough to have it grow at the same level. So part of it is just math and nothing else.

Part of it has to do with definitely protectionism and also some exchange rate considerations that affect the patterns of global trade. If global trade is curtailed, which we don't think is going to be the case -- we think around every election there's a lot of talk of protectionism. But people know that the people that want protectionism are the very people that actually get hurt by it in the long term. We think notwithstanding the talk around the election season, there's going to be very little. In fact, we think that TPP is going to go forward then maybe create opportunities in the other direction.

But let's assume for a moment that we're all wrong and the politicians will get in the way of global trade. Well, you just have to carry more inventory because you're not sourcing it from as many places. The big drivers of demand, though, are consumption fueled by e-commerce and reconfiguration of the supply chain. Those are the real biggies now that global trade has reached the saturation point.

Craig Mailman, KeyBanc Capital Markets.

Hey, guys.

Just curious, on your views here over the next 12 to 24 months on market rent growth, given the positive supply/demand dynamic; and really what you guys see as your ability to push rents before you get too much pushback from tenants.

And then separately, we've talked in the past about maybe cap rate compression stabilizing in Europe. It sounds like now, post Brexit, that may not necessarily be the case. And your views of when rent growth may start to materialize there in a significant manner.

So Craig, it's Gene.

I'll start with the US and I'm sure Gary will comment on what's happening with Europe. We basically continue to get more bullish as we get each quarter behind us. We're surprised to the upside and what the fundamentals look like in the US -- and I would include Mexico in that at this point as well. I think we are probably talking about a 5% or something next year. I think we're going to do better than that.

As I said on the last call, I think equilibrium in the US markets is probably some time in 2017. Again, I'd remind you, when we reach equilibrium, we'll be at all time low vacancy rates and you still have plenty of room to push rents. So I'm probably slightly more bullish than I have been in the past in the US.

Let me add something to that. I mean we can speculate what market rental growth will be, but the mark-to-market on leases right now, as we said, with no further rental growth would be 15%. And if you assume no further growth from here and you realize that over the next four years the 15% mark-to-market -- that gets you pretty close to 4% same-store growth with zero additional rental growth. So it's not as if it takes a lot of imagination to get to strong same-store growth numbers in the US. The mark-to-market is the driver.

Gary?

Yes, on cap rates: before Brexit, we were projecting 15 to 30 basis points over the next 12 months on the continent, relatively flat in the UK. But look, the ECB and the Bank of England are under a lot of pressure. It's widely believed that interest rates are going to go lower. So obviously that has downward implications, potentially, on cap rates.

Vincent Chao, Deutsche Bank.

(technical difficulty) in the UK and in Europe and your outlook for cap rates, et cetera. But still maybe in an uncertain environment, I think we can at least say that's the case. I guess at this point, would you be more inclined to increase your investments in Europe and specifically the UK? Or decrease at this point?

We're not looking to decrease -- first of all, we didn't hear the first part of your question, but I think based on the last part, I can get the gist of where you're going. Our business is just a real estate business and we're not a hedge fund. We don't make decisions minute by minute. This is a long-term business. We got a good allocation, appropriate allocation to Europe. A lot of this stuff is based on long-term prospects for economic and population growth.

Basically, we are invested the way we are across the world for a reason. Over time the only portfolio shift that we imagine has nothing to do with Brexit. We probably want to be a little heavier in Asia and a little lighter in Europe, but fundamentally our allocations, regardless of Brexit, are where we want them to be. The big dial we use in terms of managing our own allocation is our share of our private capital vehicles. That's really the way we manage the business from our capital exposure. We like our scale in Europe because we're the dominant player there and have the best portfolio. We really like that market position and what it means in terms of what we can do with customers.

So a long-winded answer of saying that we like our hand, we like our position in the UK. We're willing to -- we think that the UK is going to continue to be the best market in Europe, actually, in the next 10 years. It might take a pause in the short term but the long-term dynamics of it are quite interesting. So we're good where we are. Now, if opportunities arise, and people start doing stupid things, we would be delighted to take advantage of those things. I don't think it will happen. I think by and large European real estate is in strong institutional hands. There's not a lot of leverage in the system, notwithstanding the headlines that you hear about some of these open-end funds. And there may be pressure, by the way, on financial center-type office buildings in the UK. But in our product type, we think there are more buyers than sellers of the quality of product that we have. So we don't think those distressed opportunities are going to materialize, but if they do we're prepared to take advantage of them.

John Guinee, Stifel Nicolaus.

One three-part question.

Someone told me a while ago that dividends now matter and we noticed that you increased your net earnings S range to a $1.70 to $1.90. Talk about what that does for your dividend. Second part of the question is, are you thinking about any other markets globally, given that you've got an abundance of cash? And then third, can you talk a little bit about land prices in the tighter industrial markets and how that's affecting replacement cost rents?

John, I'll take the first one on dividends. Yes, we did see an increase in our EPS this quarter. It was a combination of two things: one, just higher realized development gains; and also just higher disposition activity -- what we would call non-development gains, non-FFO gains of operating properties increasing our disposition activity. That's what's driving that. No change in our dividend; we're happy with where our payout ratio is. Our payout ratio right now, based on our AFFO, is about 68%. We're comfortable with where that is and we've obviously had extremely good dividend growth over the last several years. But we see the dividend holding where it is this year.

Hey, John, the dividend that's been up 50% over the last, I think, two-and-change years, from $1.12 to $1.68 -- I would be surprised if the dividend rate doesn't grow by multiples of inflation going forward. We think our FFO growth is going to be pretty strong and we've got good leverage coming through G&A, which is not growing nearly as fast, it's actually flat compared to our operating earnings. So I think we've got good leverage to grow our dividend above industry rates -- pretty clear about that.

We are not planning to go to any new markets. In fact, we're in the process of completing our strategic plan, Vision 2020. And in it, it doesn't contemplate going into any new markets. It is totally based on deepening our presence in the markets we're already in.

And with respect to land and replacement costs, I think land in the US has appreciated quite a bit. And I think the constraints on land and its entitlements are significant and will continue to put pressure on some of the most desirable markets in the US, like California and the Pacific Northwest and Miami and the like. The markets that are supply-constrained, I think there's very little land and very tough to get it entitled. So I think replacement cost rent numbers are going up and up in the US.

I think land prices have recovered in Europe, but we don't see them zooming ahead because the rents are still relatively slow-growing in Europe. They're growing but they are much slower-growing than the US. So land has recovered but it's not zooming ahead. In the US land is pretty expensive.

The only other thing I'd add is Asia. It's probably one of the more interesting markets with respect to land. Somebody asked a question earlier about our development volumes in China. Obviously they're increasing, but each incremental piece of land that we buy in China, even if it's Phase 2, is incrementally more expensive than the land we just acquired right next door. As a result, you're seeing market rent growth there continue in that 4% to 5% range, depending on which sub-market you're talking about.

And in Japan, probably the most expensive land market in the world. And the other thing that's impacting replacement cost rents are construction costs. Our team expects that the back half of this year you're going to start to see construction costs rise again as we approach the 2020 Olympics and construction resources become scarce.

So I think Asia is a pretty interesting place with respect to the land market.

Tom Lesnick, Capital One.

Thanks for taking my questions.

I wanted to take a minute to focus on the smaller unit size portion of your portfolio. Roughly a third of your portfolio is under 100,000 square feet and that also represents the lowest occupancy, similar to the portfolio, at around 94%. Wondering if you could provide any update on what you're seeing in terms of tenant health in that segment and trends broadly, both in the US and Europe?

Yes, Tom, it's Gene, I'll talk about the US.

This segment, as you know if you followed us over the last several years, has really recovered. I think we were in the high 80%s for occupancy under 100,000 square feet coming out of our merger. And now that's the 94%, 95%, in that range. You're probably not going to see those size increments move a heck of a lot higher because you have many more spaces, you have naturally shorter lease terms and more roll. I'd say that's pretty full. In fact, historically -- and we could take a look at this -- I'm not sure that segment really gets much higher than that.

But having said that, the demand is good. You're going to see us bounce around quarter to quarter, but demand is good from those tenants. And probably the single most important customer segment is home building and that really hasn't returned. If it does, perhaps it pushes a little bit more. But we're not concerned about it in terms of where we're at. We're probably topped out.

Gary?

With respect to Europe, this is a place that we've -- this unit size thing is a thing that we've talked about on past calls. There's definitely an opportunity for us to make progress in Europe. We're currently, across the whole of Europe, about 91% occupied in small spaces. Again, we look at that in terms of small business formation. The place that we've liked the most is in southern Europe where, candidly, you've had the least amount of small business formation. But we have been focused on that segment even in southern Europe. And if you look, we've probably gained 1,200 or 1,400 basis points over the last year in our Southern European portfolio. So it is an area of focus and one where we think opportunities lie, certainly in Europe.

This is Tom.

I would add that I think this segment has the most NOI upside. It's the last to recover. These spaces are generally the most infill. They have the highest rents per square foot. I think now that you're seeing it seems that these spaces stabilizing, I think that's going to allow us to push rents. Its got a little more to catch up, so I think a lot of NOI tailwind from this segment, as well as Gene talked about, home building not really driving that, but clearly e-commerce is moving into that space and will be a big driver. Again, I think that is just more NOI upside for us.

And really high replacement costs, really tough to rebuild this stuff.

Manny Korchman, Citigroup.

Hey, guys.

Hamid, if we go back to your answer to -- your comment earlier -- on equity, what would make you be more open to issuing equity? Would it be the type of deal? Would it be pricing? Let's just think out loud for a second. And if you were to do something like a KTR today versus when you got that completed, would there be an equity component now with your stock where it is? Or are you against equity for other reasons?

Look, it's not a religious belief. I believe in equity when there's a good use for capital deployment and all that. A lot of people thought that we needed equity for balance sheet purposes to achieve our A rating, and unfortunately they were wrong. We were very clear that we didn't. We have liquidity from internal sources, fund rebalancing, non-strategic asset sales, and the like, to fund our business going forward -- our development business going forward -- for five, six, seven years on a normal steady-state scenario.

The only thing that's not in that plan is an opportunistic large acquisition. If we run into those, we go into hibernation for a couple years and once in a while we come out and do something big and then go back in hibernation. We don't have a capital plan that contemplates those types of deals, but if they were to materialize, that's when we would take a look at equity along with other sources. But I can tell you we've got a lot of liquidity right now between lines totaling $3.5 billion and the cash that will build up to about $1 billion in the balance sheet. We got over $4 billion of liquidity and we like our currency.

I think, yes, we are now finally trading at the NAV of our underlying real estate. But still the market isn't paying us for development platforms which creates $400 million to $500 million NAV like clockwork every year. So -- long-winded answer, but equity is not the first place we would look to fund even a strategic transaction. There are other places we can go to do that, including private capital and our liquidity resources.

Brad Burke, Goldman Sachs.

Hello, everyone -- a question on cap rates.

You're making acquisitions and dispositions with cap rates in the mid 6%s this year, and that's quite a bit higher than what we're hearing from market cap rates, and also above what we saw you do last year. So want to understand what would be driving that, whether it's a mix issue or something else?

This is Mike, sorry a little frog in my throat here. With respect to our disposition cap rates this quarter, it was up a little bit at 6.5%. Two primary reasons: we're active sellers in some regional markets like Cincinnati, Reno, parts of Spain. The average age of the portfolio as we sold it to our global markets was twice the average age of our portfolio. So between regional mix and age we saw a little bit of uptick in cap rates. We expect that to normalize on dispositions throughout the rest of the year.

Steve Sakwa, Evercore.

Thanks. Most of my questions have been asked.

Hamid -- big picture, everything seems to be going very well in the business and you guys are even more optimistic today than you were six months ago. What are the potential storm clouds that you're watching that would cause you to either take the development starts down or to get more cautious on rent growth or NOI growth over the next, say, 12 to 24 months?

Steve, I think it's things outside the real estate market. We are living in a pretty difficult geopolitical environment. And there's some domestic issues going on that are very concerning that could have [subvert] to the economy. So those kinds of things all argue for having a prudent capital structure so that you can go through any scenario and maybe even capitalize on some opportunities that come up in those kinds of scenarios, which is not a position we're in, in the last cycle. We have learned our lessons and I think we're adequately prepared for those types of situations.

But I don't really see anything on the real estate markets that concern me. Remember, demand was never, and still is not, spectacular. I think demand on the 10 point scale is a 6. I just think supply is a 4 to a 5, and that's what's been keeping the markets healthy. So it's really the other stuff, the geopolitical and domestic political issues. And all of the stuff that we read about in the newspapers and watch on TV -- very concerned about those.

Dave Rodgers, Robert W. Baird.

Good morning out there.

Maybe for Gene and Hamid, focusing on the US specifically -- can you detail some of the discussions that you're having with some of your current and potential customers around the development side of the business? What that tells you about your comfort with spec and build-to-suit and sizing of the pipeline going forward? And a second part to that is, I think you said in your guidance and it was written down, that you're going to take a bigger share of the development spend. Is there anything we should read into that as well? Thanks.

Dave, let me start with that.

One way to think about the risk in your development program is if you take all your vacant development, no matter what condition it's in, what percentage of your overall portfolio, development and operating, what does that represent? And over the last couple of years, when we've really ramped our development up, we've been between 4% and 5%. As of this quarter it's 3.5%. So we're, I think, fairly de-risked on that front. And then if you look at starts in the US, for example -- and this gets to the customer dialogue -- we're 89% pre-leased on the starts of this quarter because we had effectively six build-to-suits of pre-leased deals. That's a result of lots and lots of customer dialogue that's taken place over a couple of years at this point.

But most of our customers, today their focus is on how do they plan for the future. Most of them are in the midst of a supply chain reconfiguration of some type. And the markets are so tight they have to plan, they have to engage with us more on long term planning. So I think actually the nature of that dialogue has shifted dramatically. Now, it hasn't shifted just in the last quarter; it's taken some period of time. But that's why you see lease terms that are significantly longer than they were a couple years ago. We would like to think these discussions are strategic versus transactional, so I think that actually is a pretty significant change we've seen.

The only thing I would add to that is that I've been doing this for over 30 years and I have never seen an environment where customers have been as willing to share with us their future plans for growth and asking us to build more product. Literally, they are asking us to build more spec products and they are coming ahead and telling us where their needs are. They used to play their cards pretty close to their vests. Now, part of this may be a level of strategic dialogue that we've created with them. With some of these customers we have 30, 40, 50, 60 leases. You can engage in meaningful dialogue when you have that kind of customer connectivity, whereas if you have a random portfolio and maybe the customer is sprinkled in three locations, they think of you more a vendor than a partner.

So I think the business is finally getting to the scale, not only because of its size but also because of its focus on the key markets, that the dialogue is becoming more and more strategic. That's what we work very hard to create. So we're very encouraged by all of that and look to take advantage of it.

It manifests itself in very high volumes of build-to-suit, not because we want it to be that way but because it turns out that way, that people want to lock up spec capacity ahead of time. So a lot of these are spec-to-suit or buildings we're going to build anyway, that get leased up on a build-to-suit basis before we start, with very minor modifications. It a good place to be.

Michael Mueller, JPMorgan.

Yes, hello. I apologize if I missed this, but what specifically is driving the 75 basis-point increase in the same-store NOI guidance? Is it something more in the rate side, the mark-to-markets are bigger, you think you're going to end up someplace different on the occupancy range? Or something else?

Mike, it's Tom.

It's a combination of both of those things. It's the higher rates that we're seeing on roll, as well as occupancy totaling up higher than we anticipated. As you know, we're pushing rents and we were anticipating larger declines in occupancy than what we've seen. But I would say the primary driver, though, is rate.

So Michael, you remember this because you were there and actually asked us some good questions then. Back in 2012 when we laid out that crazy scenario of 25% rental growth in the US -- we've blown through that. Remember, there was another phase after that which is where would market rents go when replacement costs recovered, when construction costs recovered? Because everybody was working for nothing then and when land costs recovered. That's a whole other acceleration of replacement costs, which is really pushing rent. If you go back to that time, more like 35% from that time.

So we've been surprised by that last 10%. We thought we were being pretty aggressive. You guys thought -- all of you -- we were crazy. The market has turned out to be much more -- we were all very conservative in retrospect, and the market has blown past that because replacement costs have blown past that.

And we shouldn't really be surprised, because nominal rents today are only a few percent higher than what they were in 2000. We had a dry period of 10 to 15 years of very little nominal rental growth. And now we're finally getting back to nominal rents that we got in the early 2000s. On a real basis we're still 35% below where we should be. I'm not saying we're going to have 35% more rental growth; don't get me wrong. But I'm just saying, nominally we're where we were 15 years ago; we shouldn't be this surprised. But I guess when we were all in the depths of 2012, none of us had enough vision to project 35%, 40% rental growth. But that's what's happening.

Blaine Heck, Wells Fargo.

Just a follow-up on development. Starts in the first half were relatively low at around $660 million at your share, which is about a third of guidance, which leaves almost $600 million per quarter to start in the second half to hit guidance. Was the low level of starts during the first half attributable to regular seasonality? Or does that have anything to do with you guys looking for more build-to-suit projects that may be harder to get the same volume as when you were doing more spec development as well? And then, what should we look for as far as the timing of the remaining $1.2 billion of starts at your share this year?

This is Mike Curless, let me address that.

Relative to the 35% activity through the first half -- that might seem low compared to last year, where I think we were at 54%, which was unusually high for the first half of the year. But historically since the merger, we're always between 30 and base because there is some seasonality here and a lot of our work and the development starts activity is definitely back-end loaded.

So we have clear visibility to 100% of the items on our forecast this year, which is very good visibility at this time of the year. At the end of the day we'd expect about 45% of this activity to take place in the Americas; call it 30% in Asia; 25% in Europe. That's about the same in Americas as last year and a little bit down in Europe and a little bit up in Asia. Our confidence level is high to finish through this, particularly given the robust activity we're seeing in the build-to-suit arena, which is driving confidence for the second half.

I think the risk to our start number this year is to the upside not the downside.

I agree.

Eric Frankel, Green Street Advisors.

Thank you. A follow-up on your comments about supply. Could you provide a little bit more color as to markets where you're seeing supply issue? I think you mentioned Houston and Columbus. With Houston, does the supply actually impact your portfolio? Am I understanding that there's a lot more activity surrounding the port and the downstream portion of the petrochemical business, so that's what's driving supply there? But any additional color on those markets and others would be appreciated. Thank you.

Yes, sure, Eric, it's Gene.

You're correct about Houston, that's where the supply is. Our portfolio is primarily Northwest and it's pretty built out; there isn't a lot of supply. But if you look at the raw numbers in Houston, it is in an over-built condition. It still has positive absorption, which surprises a lot of people, but it is over-built.

Other markets that we've called out -- Columbus, again not a horrendous situation. But they have excess supply and they have a forward pipeline that concerns us. And otherwise, we look at this all the time as you know. Other markets just don't scream bad at this point. Dallas has a lot of construction going on. And Dallas has a forward supply scenario that has us cautious. But again, a lot of that is in south Dallas. Most of our development and most of our portfolio is around the airport and in north Dallas. I could go on about other markets, but the reality is that we're in pretty good shape in these markets in the US.

There's something else I'd point out, Eric, and this is worth noting and watching going forward. We've called out a couple of markets historically over the last several quarters -- Indianapolis is one of them, Central and Eastern Pennsylvania. And what's happened -- and frankly, I haven't seen this happen before in my career -- is markets got close to an over-building situation or maybe a little bit over the line and they've corrected. So both of those markets are actually -- they've taken the foot off the gas, they've lowered the supply levels and made they've made corrections. There's a couple of other markets that -- New Jersey would also fall in that category, by the way. That's really good to see. Again, we got to watch this every day, but we continue to be very pleased with the overall discipline.

Eric, the only thing I would add to what Gene said is that the only place I see around the world where truly stupid things are happening is Poland. I mean, it is irresponsible with a capital I. You've got literally people signing leases on build-to-suits with face rents that they then discount with three years of free rent on a 10-year lease. And there's some investor that comes up and buys it at the cap rate they think is the cap rate. And they do it with side letters and all kinds of games that are really not good for our industry's reputation. We are concerned about that and we will speak about that. As I mentioned to you a couple quarters ago, we have a real stake in making sure that investors are making intelligent decisions.

By the way, Poland is -- before everybody gets all excited -- Poland is 2% of our portfolio. And this is really only happening in a few locations in Poland. But it is concerning. It sort of reminds me of Dallas in 1997 and 1998. Some people are going to get burned doing that and then they will stop. But at the moment, that's the only place in the world that worries me.

The only comment that I would add, Hamid, is that the impact will not have any impact on our existing Polish portfolio because we value our assets on the net asset or a net effective rent basis. So there should be no impact there. But I have to tell you, these investors who are buying these headline-capped assets are not going to be happy when these assets or leases roll.

We're going to be calling on those tenants. (laughter)

Manny Korchman, Citigroup.

Two quick follow-ups.

On leasing, it looks like you took care of a lot of -- or at least a bunch of -- expirations for 2017. Could you tell us how you thought about doing those renewals early, especially it sounds like things are going in the upward direction? And my second question is, if we look at your development margins, which seem to be coming down at least quarter over quarter, is that just a mix issue and it's because you're doing more build-to-suit? Or is there more to it than that?

Let me hit the development. Development markets have been crazy good. And a lot of it has to do with the fact we are monetizing low cheap land from the downturn that was impaired in all that. I think at market, with market land values our development margins are more normal. They're still high but they're more normal, they're not crazy high.

Remember what we said about development margins. In a steady-state market, which we're not in yet, we're better than this. But when the market is totally steady, spec should be around 15% and build-to-suits should be 10% to 12%. Right now we're probably at market 5 points higher than that for both spec and build-to-suits. More for spec; I would say build-to-suits are 10% to 12% when they get to be really competitive.

So we've just been spoiled by really good margins. And we haven't built our business or our forecast based on 30% margins like we had last year.

And then on the leasing question, we're always pulling leases forward; it's just a part of how we run the business. There really isn't any strategy around that. We're not specifically targeting any particular vintage of lease. Really it has to do with the customer's interest and other things. You're going to be able to continue to see that in the normal course of business.

Hey, Manny, it's Tom. I just had one more thing.

When you look at the net effective rent, in the remaining 2017, what's rolling our share -- that actually dropped from last quarter. So our discussion about NOI growth going forward and the very positive mark-to-market, I think that's a really good sign when you think about how high our rent change on roll was this quarter. And we lowered our net effective in-place rents in 2017.

So that was the last question. I think it's only appropriate to end this call with a cheerio from all of us here at Prologis. (laughter) See you next quarter.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.