Prologis Inc (PLD) 2017 Q3 法說會逐字稿

Welcome to the Prologis third quarter earnings conference call.

My name is Christine, and I will be the operator for today's call.

(Operator Instructions) Please note that this conference is being recorded.

I will now turn the call over to Tracy Ward.

You may begin.

Thanks, Christine, and good morning, everyone.

Welcome to our third quarter 2017 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 strategy and outlook; and 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, Diana Scott, and Chris Caton.

Before we begin our prepared remarks, I'd like to state that this conference call will contain forward-looking statements under federal securities laws.

These statements are based on current expectations, estimates and projections about the market and the industry in which Prologis operates as well as management's beliefs and assumptions.

Forward-looking statements are not guarantees of a 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 on our 10-K or SEC filings.

Additionally, our third quarter results press release and supplemental do contain financial measures such as FFO and EBITDA that are non-GAAP measures.

And in accordance with Reg G, we have provided a reconciliation to those measures.

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

Thanks, Tracy, and good morning, everyone.

I'd like to begin with a few comments on the operating environment.

In the U.S., market conditions remain excellent.

Consumption has been growing at a faster pace than available stock, leading to very tight market conditions.

At the beginning of the year, we highlighted an elevated level of development starts, which will show up in higher deliveries over the next few months.

However, new starts moderated in the second and third quarters, leading to development volumes that fell short of demand.

This shortfall is further boosting market rent growth across our U.S. portfolio.

For the first time in my career, net absorption is being constrained by a serious shortage of space.

Tight land and labor markets are acting as governors on new construction.

We are hearing consistent feedback from our customers who tell us that they're operating at capacity and that it's difficult for them to find additional quality space in the right locations.

These favorable conditions have elevated the mark-to-market in our portfolio.

In-place rents in the U.S. are now 18% below market, extending our organic growth for a long period into the future.

A similar dynamic is playing out in Continental Europe, which has lagged the U.S. by more than 4 years in this cycle.

Construction costs are escalating rapidly, driven largely by labor, which is making new development more difficult to pencil.

Market rent growth has been muted over the last several years, largely due to the massive headwind from cap rate compression as well as uneven demand.

As you will recall, we anticipated this cap rate compression and invested heavily in the region between 2011 and 2014.

Two recent portfolio transactions in the market point to a significant value uplift in Europe.

Going forward, rental rates will be driven higher, given improving customer sentiment and record-low vacancies.

Continued recovery on the continent will extend the growth trajectory for our company beyond what would have been possible with an exclusively U.S. portfolio.

Looking to our business strategy, I'd like to highlight 2 key points.

First, our initiative to simplify our business is now complete.

Last night, we closed on the combination of our 2 open-end funds in Europe.

This marks the culmination of our efforts to reduce the number of co-investment ventures from 21 at the time of the merger, to 8 today.

Over the same period, we doubled third-party assets under management to $30 billion and increased the proportion of perpetual or long-life vehicles from 60% to over 90%.

We now have a single sector-leading core open-end fund in both Europe and the U.S. that are each over $9 billion in assets.

Our current structure is far more streamlined, understandable, and I might add, profitable, and will allow us to grow in the consumption markets that matter the most.

Second, our ability to source and allocate capital globally is unparalleled.

Our scale and global reach give us access to attractive capital sourcing and deployment opportunities around the world.

So far this year, we've raised over $5 billion in long-term debt at a weighted average interest rate of 1.7%, the vast majority of which was in yen and sterling, and matched against our assets in those currencies.

This quarter, we deployed 450 million in Brazil to buy out our partners and to control our platform at a 9.2% cap rate for operating assets.

While this sourcing and investing of capital were not explicitly linked, these transactions illustrate the advantages of a global platform in terms of opportunistic capital allocation, all while reducing the currency risk in our portfolio.

I'll sum it up by saying that I feel great about where we are today.

Operating conditions continued to test new limits, and market selection has never been more critical.

Looking forward, our portfolio quality, streamlined strategic capital franchise and global reach, will further separate us from the pack.

The next few years, it will be all about organic growth and opportunistic capital allocation.

With that, I'd like to hand it over to Tom.

Thanks, Hamid.

I'll cover the highlights for the quarter and provide updated 2017 guidance.

We got another great quarter, with core FFO of $0.67 per share.

Operating condition in our markets continued to be excellent, and our results reflect our customers' intensifying need for well-located logistics facilities.

In this environment, we continue to push rents versus occupancy to maximize overall lease economics.

Our results will reflect the success of this strategy.

Our share of net effective rent change on rollover was 22.7%, led by the U.S. with a record 31.9%.

This marks the seventh consecutive quarter of U.S. rent change above 20%.

Global occupancy at quarter end was 96.3%, an increase of 10 basis points sequentially, but 30 basis points lower year-over-year.

Our share of net effective same-store NOI growth was 4.1%, with U.S. leading the way at 6%.

I want to point out that we had a 20 basis points drag from Brazil in our same-store results, due to the acquisition of our partner's interest and the lower occupancy levels in that portfolio.

The third quarter is the first time this cycle our same-store growth was driven exclusively by re-leasing spreads and not by occupancy gains, which have been a meaningful contributor for several years running.

For reference, we had 100 basis points of occupancy pickup in our second quarter same-store results, with no such benefits this quarter.

Given further market rent growth and the cumulative effect of rent change, same-store will accelerate into the fourth quarter.

In addition, the spread between market rents and our in-place leases widened again this quarter and is now 14% globally and 18% in the U.S. This further builds up our embedded earnings potential and lengthens our runway for NOI growth.

Moving to capital deployment for the quarter.

Margins on both starts and stabilizations continue to be strong, and build-to-suit projects accounted for nearly 50% of our starts.

Dispositions and contributions are ahead of plan.

And buyer interest has been excellent, with activity from a wide range of buyers.

The large contribution volume in the quarter was driven by assets we sold to our J-REIT.

We had an active quarter in our strategic capital business, closing out both the acquisition of our partner's interest in Brazil and contributing our former NAIF portfolio to USLF.

These 2 transactions generated a onetime non-FFO gain of approximately $560 million, the majority of which is attributed to asset appreciation in NAIF since the acquisition of this portfolio.

As Hamid mentioned, we just completed the combination of 2 of our European ventures.

This $9.7 billion vehicle has been upgraded to an A- rating and has significant liquidity.

While this transaction was not a liquidity event for Prologis, we have created a single profitable open-ended vehicle that is poised for growth.

There is no shortage of demand for well-located logistics real estate and experienced management teams.

Year-to-date, we have raised over $2 billion in new capital from our co-investment partners.

Turning to our credit metrics.

We ended the quarter with leverage below 24% on a market capitalization basis, debt to adjusted EBITDA of 4.3x and liquidity of $4 billion, including $568 million in cash, and no outstanding balances on our lines.

These are the strongest credit metrics in our history, positioning us with significant capacity for growth.

Moving to guidance for 2017, which I will provide on an our share basis.

We're maintaining our occupancy and same-store guidance ranges for the year.

Where we end in our full year same-store range will ultimately depend on average occupancy, given our focus on pushing rents.

In addition, our increased investment in Brazil will also have a moderate drag on the full year.

However, both of these strategies will bolster our same-store NOI in the long term, which is always our focus.

We expect our G&A to now range between $228 million and $232 million, up from our prior guidance due to FX as well as higher compensation expenses related to our share price.

Strategic capital revenue will range between $240 million and $245 million, up from our prior guidance due to FX and higher transaction fees.

Given continued robust demand, we're increasing our starts guidance by $450 million to range between $2.3 billion and $2.5 billion.

Build-to-suits will account for approximately 50% of this volume.

Based on very healthy market conditions, strong demand from buyers and visibility into our pipeline, we're also increasing our disposition and contribution guidance by $500 million.

These changes highlight the fact that we have no need to rely on the capital markets to fund the increase in our development pipeline.

In addition to our $4 billion liquidity, we have $3.4 billion of internal capacity to self-fund our growth for the foreseeable future.

These onetime sources include the rebalancing of our ventures to our long-term ownership targets and selling our remaining nonstrategic assets.

I want to point out that we will be building significant liquidity and leverage capacity in the fourth quarter, given the timing lag to reinvest disposition and contribution proceeds back into development.

Based on our revised guidance, the development pipeline at the end of 2017 will be approximately $600 million higher than it was at the end of last year.

Putting this all together, we're holding the midpoint of our 2017 core FFO guidance and narrowing the range to between $2.79 and $2.81 per share.

At the midpoint, this represents 9% growth over 2016, both with and without net promotes.

Our AFFO growth will be even higher, driven by cash same-store NOI growth of more than 6%.

To wrap up, we had an excellent quarter and are on track to close the year with strong continued momentum.

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

(Operator Instructions) Our first question comes from Craig Mailman from KeyBanc.

Maybe on the development starts.

I know you said build-to-suits was 50% of the increase.

So maybe just give a little bit of a color of how much you're kind of pulling forward from what you thought you would start in 2018, and maybe a little bit on which geographies are driving the ramp here.

And then, maybe, also, second, Tom, just on the timing differential on dispositions and redeployment.

Is there any way you can give us sort of a sense on FFO in terms of pennies?

Kind of as we think about transitioning from 4Q to 1Q '18 run rates?

Yes, what our -- this is Mike Curless.

Why don't I hit kind of the geographic distribution, on the first part of your question.

The way we see it shaking out this year is approximately 45% in Americas, 25% in Europe, and 30% in Asia, which is pretty typical in the last couple of years, and we're seeing good solid demand in all 3 of those geographic segments.

Yes, and in terms of pulling forward from next year, we are not going to get into providing guidance, but I think you should expect us to be doing a similar volume to the range that we've indicated for the long term next year as well.

So I don't think there is any pulling in going on here.

And then, Craig, as far as your question around the drag, in my prepared remarks, I talked about the increase in our development pipeline based on our starts and guidance.

We would be up about $600 million year-over-year.

So if you think about that $600 million and you think about a yield on that, you're looking, really, at $0.04 to $0.05 impact from that on a year-over-year basis.

Our next question comes from Jeremy Metz from BMO Capital Markets.

Hamid, as we sit here today, you mentioned the portfolio was about 14% global mark-to-market and the U.S. is around 18%.

So do you think about closing that gap and getting to -- as you think about closing that gap, how many more years runway do you think this kind of provides us, if market rents were flat from here?

And then, as we look out in 2018, not looking for guidance, but as we think about 2018 rent expirations, how do they compare to that?

Is there more room in '18, and then maybe slows a bit from there?

Or is there a bit less in '18 and the mark-to-market opportunity accelerates from there?

Sure.

Every time I answer that question, I find myself coming back to a year later and basically giving you the same answer, because the rent growth has, in the last couple of years, exceeded our expectations.

So the runway -- the mark-to-market keeps getting extended.

You may remember that a couple of quarters ago, maybe a year ago, we had a 12% mark-to-market.

We burned through a lot of those early low leases, yet our mark-to-market is now higher.

So it just seems like we're chasing really incredible rental growth, and we've been conservative, certainly in the last couple of years.

And surely, that will change at some point.

Although, I don't think it's changing anytime soon.

So we would have said '18, '19 is the year.

Probably now I would say 2021 is the year, because even if rent growths flattened out, and it's not going to go from 9% so far this year in the U.S. to 0. I mean, it will gradually moderate.

You can see multiple years of 4%, 5% same-store NOI growth.

And then, the great news about our portfolio is that that's just the time that Europe is really coming through in a big way.

So I think, absent a calamity, I think you can kind of count on many, many years of strong same-store growth going forward.

I don't think this is one of the things that -- I think people pay entirely too much attention to quarter-by-quarter trends as opposed to sort of longer-term trends.

And the longer-term trends has -- have been remarkable.

I mean, far in excess of our expectations.

I'll give you a little color on same-store.

So some things to think about.

As we mentioned, this is the first quarter where we had no occupancy pickup in our same-store pool.

So from here on out, you should think about same-store being driven almost exclusively by rent change on roll and not by occupancy.

We think occupancy levels were pushing rents, as you know.

So occupancy levels don't see any upside from here at all.

So now you got to think about what rent change is.

And you really need to think about rent change on a rolling 4-quarter basis, because that's what impacts your same-store pool.

And when you look at trailing rent change for the last 4 quarters, Q3 '17 was the first quarter that's above 20%.

It's about 20.7% rolling 4 quarters.

And when you think about what that number's going to do going forward, that number is going to grow.

I would expect that number to consistently be in the 20% range all next year.

And if you look at just the components, our rent change in Q4 of 2016, by itself, was 16%.

So we're going to drop off a 16% rent change quarter, and we're going to add something in the fourth quarter that's got at a 20 in front of it.

So I think, the trend is, the rent change on roll is only going to increase when you look at roll for 2018.

I don't think there's anything unique in 2018 versus '17, with the exception of our roll is going to be a little lower.

Our next question comes from Manny Korchman from Citi.

Maybe, Hamid, as we look at sort of that growth in your accelerating development pipeline, how do you think about sourcing land?

And has your approach to either where the land is or the type of land you're buying changed?

Not really.

It's -- buying land is getting more and more difficult.

Because the buildings are getting bigger, which means the land requirements are getting bigger.

And also, coverage is getting lower by the way.

So the pieces of flat land that you need in these major metro areas where we are active is getting really hard to come by.

So -- and we're fortunate to have a fair amount of land in the balance sheet.

And so I think the opportunity is pretty good for us for the next couple of years.

But I got to tell you, sourcing land is one of the most difficult things in our business.

There's plenty of land.

It's just good land that's hard to source and municipalities are getting very difficult with respect to approvals and exactions and costs for services and everything.

And then, in some jurisdictions, the unions are getting very tough and construction costs are getting more and more difficult.

So I would say land, generally, is becoming a more difficult topic.

Our next question comes from Jamie Feldman from Bank of America.

I guess, thinking about the consolidation of the funds business, your investment this year kind of doubling down in Brazil, can you just give us your thoughts on the global landscape, where you think the best opportunities are, and what we might expect to see?

I know you're not giving guidance for '18.

But just as you guys look ahead to '18, how much large-scale investment activity might we expect to see?

And how much consolidation activity?

Yes.

We're not planning on any of it, Jamie, because we tend to be opportunistic.

And look, there are a lot of big portfolios that have transacted in the last couple of years that we have not participated in.

We've been in every one of those.

We've looked at every one of those, we've evaluated them, but we've been pretty disciplined in our pricing.

And frankly, our proprietary deal flow in our funds and all that has been better than external deal opportunities.

So that's where we've chosen our capital dollars, that and development.

Going forward, we're just going to have to see what the opportunities are.

We do not, as I've said many, many times when it comes time to giving guidance, and people say, "What's your acquisition guidance for next year?" And I'd say $0 to $10 billion.

And we've exceeded the $10 billion in 1 year actually.

So I -- it's not something that we budget or predict, because it depends on pricing.

We can make it be whatever we want it to be, but that's if we're not disciplined to price, which we are.

So we're just going to have to wait and see.

Qualitatively, I would tell you that more of our acquisition activity is likely to be value-added, where because of our customer franchise and our development expertise, redevelopment expertise, et cetera, we can create a lot of value.

A good example of that would be for example, this building that we recently did in the Bronx.

So where -- you can see us -- expect us to do a lot more of those kinds of transactions, but going out and getting into a war on declining IRRs, a race to 0 on cap rates, that's kind of not our deal.

We've got to have some kind of a competitive advantage.

Our next question comes from Steve Sakwa from Evercore ISI

Hamid, I guess, the follow-up on your comments about kind of the slower pace of leasing being a function of how well occupied you are and tenants operating at kind of full capacity, are you sort of changing your thought process on development and kind of the mix between the build-to-suits and the spec, just given, maybe, the opportunities that are out there?

And how do you sort of think about that going forward?

Yes, Steve, I don't think the pace of leasing is slowing down.

I think the absorption is slowing down because there isn't enough space to lease.

So I think the -- I guess I would say the interest and the desire on the part of tenants to lease space is as high as it's ever been.

It's just not translating into as much absorption because they can't find the space that they need.

And we are hearing that time and time again.

We had our customer advisory board meeting about 1.5 months ago in Atlanta.

And the uniform message was, "Guys, we never thought we would say this, but we don't kind of care a lot about price.

We just need the space because our business really needs to grow." We've never heard that before from customers, and we're hearing it from multiple customers at the same time.

In terms of the implications of that for our development business, I would say, at the margin, the thing that's been a surprise is the volume of build-to-suits.

And the volume of build-to-suits is because people can't find the readily available spec space that they can go and lease.

And we've been able to derisk build-to-suits at very significant margins.

So if there's a surprise anywhere in this, is that our normal 25% build-to-suits is now 50%, and that's translating into incremental volume.

The 50% spec that we were kind of doing is the same number over time.

It's the build-to-suits that are way up.

Our next question comes from Blaine Heck from Wells Fargo.

Hamid or maybe Gary, can you guys talk a little bit more about operations in Europe?

Occupancy slipped 80 basis points sequentially, but I'm wondering if that's because you guys are actually pushing more on rents.

So if you can give any color around that.

And maybe, what where your rent spreads in Europe during the quarter?

That would be helpful.

Yes.

So it's Gary.

The occupancy drop, I wouldn't get too worried about.

We dropped 80 basis points in the quarter down to, I think, 95.4%.

There was no real single driver.

We had a handful of fairly large recent rollovers in the U.K, France, Belgium and Poland, but I wouldn't read anything into that.

In fact, I would expect occupancy to tick up next quarter.

In terms of rent, the thing that has held rents back in Europe is a significant cap rate compression that Hamid talked about in his opening remarks.

But if you look at, on our trailing 4 quarters or even 5 quarters, for both rent change and same-store NOI, both have an upward arrow.

And I think that should be indicative of how we're thinking about that market going forward.

Yes, Blain, just to reinforce what Gary is saying.

The cap rate compression in Europe has just been incredible.

And we've created a lot of NAV, maybe not quite the same rent growth as the U.S., but certainly, more NAV.

There's been more cap rate compression in Europe in the last 2 years than there has been in the U.S. by a factor of 3. So we're getting it in NAV.

We might not be getting it quite in rent growth, but NAVs can go down to a -- I mean, cap rates can go down to a certain level.

And then, at that point, they're going to stop, and it's going to translate into rental growth.

Our next question comes from Michael Carroll from RBC Capital Markets.

Can you guys provide us some color on the supply outlook?

What happened that drove the activity to pick up in the 1Q?

And why did this drop-off in 2Q and 3Q?

What's limiting this activity, especially given the recent rent trends and your other comments that tenants are less worried about the overall price today?

I don't think it was anything conscious.

I think it was just a quirk, and you had a bunch of starts in the beginning of the year.

Maybe it was weather related.

I don't have a good theory on that.

But all I can tell you is that the facts are, we had a high level of starts in the first quarter, and it petered out in the second and third quarter.

So supply is pretty tight.

And there is a lot of discussion about, when is supply going to finally exceed demand?

And we've been torturing ourselves for the last 2 years trying to guess that number.

The numbers are between [2 20] and [2 25] one way or another, kind of in that order of magnitude.

That's what we see going forward.

Whether supply and demand are 5 million feet short or 5 million feet too much, it doesn't matter.

Vacancy rates are under 5%.

There is ample pricing power.

And frankly, I think, there's pricing power up to 6% or 7% vacancy.

Some of these markets are 2% vacant.

So I don't think -- I think we should watch the absolute levels of supply and demand, how they relatively compare to one another on the margin.

When the differences are so minute, I think -- I don't think it's as instructive.

Our next question comes from Dave Rodgers from Baird.

Hamid and Tom, you talked about, I think, the 3 major capital sources for your business internally, noncore asset sales, the development contributions, and fund rebalancing.

Can you talk about how the capital that's chasing your business are looking to partner with you today, helps you rank each of those 3?

Just trying to get a sense of, are we seeing any meaningful shift in capital where it might make sense to pursue one versus the other?

And a clarification, Tom, did you say same-store NOI would accelerate into the fourth quarter?

Or just the rent change on rollover

Let me take the last piece first.

Yes, same-store NOI growth will accelerate from Q3 to Q4 level.

Yes.

So I would say a lot of our -- the way we approach the business is that we have a business to run.

That's the first set of decisions we make.

Where do we want to develop?

Where do we want to acquire?

How do we want to serve our customers?

That's where it all starts.

We don't go talking to the investors to figure out how much we need capital.

We talk to our customers.

And that's what drives the opportunities.

Then, we go look around and see where the best place of funding it is.

Obviously, we have idle cash that's earning nothing on the balance sheet.

That's a good place for it to go, because in effect, the opportunity of that capital is the lowest.

And frankly, we've been in that mode most of the time.

That's why all the development is taking place on balance sheet, essentially.

85% of development is taking place on the balance sheet.

Because combined with the low opportunity cost of that capital, immediately, there is also a land, which we already own.

So the return on the incremental investment, which is just the building, is really high.

So the first order of investment priority for us is to put our land to work with incremental capital from the balance sheet in development.

And then, we have is vehicles established, which set our strategy for the long-term ownership of these assets, and that's where these assets end up.

So we need to capitalize those vehicles in usually the private market.

In the case of Mexico and Japan, actually it's in the public market in those places.

But then we go find the capital for doing that.

The rebalancing of our interest into ventures is a really good way for us to deploy capital when we have excess capital.

When you see us having excess capital, like right now, that's when you see investments in our ventures being 30% or 28% or whatever high percentage.

Our real long-term strategic objective is to be around 15% in those vehicles.

So there's a lot of excess capital in those ventures today, that in the long-term, will come down.

And by the way, our investors are totally fine with that, because even 15% of capital in a 9 by then, 10, $12 billion capital, is a couple of billion dollars of capital.

So nobody is worried about -- or not being focused on this.

So that's how we approach the business.

It starts with customers.

It starts with the opportunity cost of capital.

And then, we need to find permanent homes for these assets that are created, and that's when we go to our strategic capital business.

Our next question comes from John Guinee from Stifel.

Great.

Great.

Well, just a comment, Hamid, it seems like a long time since you were rationalizing and getting a lot of pushback on the KTR deal.

Congratulations.

A couple of things, one is we noticed that the debt plus preferred stock went down about $900 million quarter-over-quarter, combined with cash on hand up by $300 million.

If you could talk about what major transaction drove that unusual combination?

And then, second, looks like your net earnings for 2017 is about $3 a share.

And I understand that's not taxable earnings, but can you talk about dividend pressure?

I think your dividend's about $1.76 a share right now.

Well, John, let me start by thanking you for making that comment about KTR.

I really appreciate it.

But let me turn the heavy lifting on your question to Tom.

So on the debt drop, it's largely attributable to the NAIF transaction into USLF.

So we transferred debt in there as well.

So you have to look at the transaction by its components.

So that was the main driver of the decline in debt.

And plus, we did generate significant proceeds during the quarter, primarily through the Japan contributions.

so that was also used to reduce leverage.

Regarding the dividend, I do -- I don't foresee any need for a special dividend in 2017.

But I would tell you, we're sort of at the limit of paying out the -- covering our taxable income.

So I would think we're going to see dividend increases going forward somewhere between that base level of -- to cover the TI up to what our AFFO growth is.

John, I can't tell you how stressed he looks when he says all of that.

Our next question comes from Eric Frankel from Green Street Advisors.

First, I wanted to thank your team again for hosting that Investor Tour in Europe last week.

It was quite informative.

So I thank you for that.

Second, just related to global trade, which has obviously been a traditional driver of your business.

Any comments on the NAFTA discussions that are taking place?

It doesn't seem to be going all that well.

I think the U.S. seems to be -- I think there seems to be a little bit higher odds that the U.S. is going to back out of the trade agreement.

So any thoughts that you can share, or what your customers are thinking, would be appreciated.

We'll let Chris Caton cover that one because it's in the realm of speculation.

Eric, thanks for the question.

Yes indeed, there seems to be a bit more news and noise on NAFTA lately.

It seems to regard the pace and tenor of those negotiations, and then, some would suggest new risk to the agreement.

But I also think it's symptomatic of a change in how the U.S. negotiates agreements.

And so look, on NAFTA, I think we'll continue to see that noise.

The U.S. may initiate a withdrawal, which is a 6-month window to continue discussions.

And indeed, the discussions are slated to continue into next year anyway.

But regardless of the direction of NAFTA, more important is its implications for our business.

Right.

And Eric, it's Gene.

Just on that note, we have not seen any fall-off in demand.

And if anything, and you can look at the fundamentals in Mexico as easy as we can, that market has been strengthening.

And recently -- look, if we go back 1.5 years, the NAFTA dialogue has gone in one direction, the other direction.

It does have an effect on currency, which we pay attention to.

But during that entire period of time, actually, demand has probably grown slightly.

And the conditions right now in Mexico are actually pretty good.

Yes.

And the only thing I have to add to what Chris said is that it makes it sound like U.S. has a very clear and deliberate strategy, which, at least judging by everything else that we've done of late, I don't see quite that level of simplification in our strategy.

But that's more commentary than fact.

Our next question comes from Nick Stelzner from Morgan Stanley.

Can you give us an update on your multistory warehouse initiatives in the U.S?

What's the demand and pricing been like across the different levels of the building?

Then also, relative to other buildings in the area?

We've leased one multistory building that we acquired.

The rent has been about 20% higher than our expectations, and probably between double and triple what quality spaces in a traditional industrial location in the same metro area.

Our Seattle building is too early.

It's not going to be even completed until mid- to late next year.

We're having good dialogue on it, but we don't want to lease that prematurely.

And the San Francisco project is not even approved yet.

So it's early.

(inaudible) the opportunity.

Oh, the opportunity is -- I don't know.

I think there is 6 markets for sure that can benefit from this type of development.

And it would not be unusual to think of those markets as sort of 5 million square foot opportunities in the next, call it 5 years.

And if you do the math, that's 30 million feet.

These buildings are about double to triple the price of traditional industrial.

So it's equivalent to roughly 100 million square feet, call it 60 to 100 million square feet of regular industrial.

So if you compare that to our U.S. portfolio of 400 million feet, it's probably a 20% -- 20%, 25% type growth opportunity if we can find the real estate and execute successfully.

But that's speculation.

So we'll take it a deal at a time in those 6 markets

Our next question comes from Eric Frankel from Green Street Advisors.

Just one quick follow-up.

Is there a specific market or geographic area where you're increasing dispositions to fund your additional development activity?

Or is it just kind of the bottom rung of the portfolio, generally?

Yes.

Eric, the answer to that question always is Tampa.

Because we've sold out of Tampa 3 times, and we keep getting back into it.

No, I'm just joking.

We're basically selling our other markets first, and we're pretty much done with that.

And then, we go to the regional markets.

And the regional markets, we only want to own the very top-tier products.

So we're selling sort of the less high-quality product in the regional market.

And then, in the core markets and the global markets that we're really interested in long term, there's always some level of 2% to 5% pruning of the portfolio that goes on all the time, in terms of upgrading the quality.

So when you add up all those, it's a pretty significant number.

I would say, we're essentially done with our nonstrategic sales in the U.S., essentially in the last $100 million, $200 million of that stuff.

And Europe, we've got less than $1 billion to go.

So we are -- we sold $14 million of real estate since the merger, so we're really getting to the bottom of the barrel in terms of what's left.

But there will be the regular culling that -- culling of the portfolio that will go on every year even after that.

And there are always some opportunistic sales that you get an outrageous offer or there's a build-to-suit that we do that we don't want to hold.

So there will be some dispositions, but the volumes are likely to decline.

Of course if we buy a major portfolio or a company or something, there could be more dispositions than that, but I'm not aware of any of those things right now.

Our next question comes from Vincent Chao from Deutsche Bank.

Just a quick question on construction cost and maybe inclusive of land.

But at this point, I mean, are you seeing construction cost growth faster than rent growth?

And then, second question, just on demand, just any changes in the source of demand by tenant type or an industry in the past 3 to 6 months?

Yes.

Construction costs are driven by labor cost in a big way pretty much everywhere around the world.

I would say, given the 9% rental growth in the U.S. to date, it would be hard to say that construction costs are growing faster than that.

But they are -- there's 5%, 6% anyway and maybe a little bit higher in the U.S. In Europe, construction costs are going up a lot, and they're going up faster than rent.

So I think development is getting tougher and tougher to pencil out, which I think is a really good harbinger for rental growth in Europe in the long term.

What's the second part of the question?

(inaudible)

Which I can take.

So in the U.S. in the recent quarter, cyclicals have picked up, and in particular residential construction and related usage of that.

And then, of course, the e-com related uses, which is in the transportation sector as well as packaging has also been strong during the quarter.

And I think last quarter, we highlighted that we saw weakness ahead for auto-related demand.

And we'll have some sort of temporary reversal of that, with at least 1 million vehicles damaged in these hurricanes.

Yes.

And then, in Europe, I'd say the modernization of the supply chain is obviously a big driver.

One of the categories within that sector is consumer goods, it's up 20% -- not up 20%.

It was 20% of the share this quarter.

Interestingly, automotive was 12% this quarter.

So it continues to be pretty strong in terms of their modernizing the supply chain.

For those of you that was -- were on tour last week, you would note, BMW and Jaguar Land Rover both preparing for electric cars and really alternative revenues.

In JLR's case you saw the classic car division and the special vehicle unit.

Within cyclicals this quarter, home appliances were 18% share.

And then, across both of those 2, obviously e-commerce continues to be a pretty significant driver and was about 17%.

Our next question comes from Jon Petersen from Jefferies.

So you talked about the lack of labor as a limiter on supply.

I'm hoping you can provide a little bit more color on that and what you think the longer-term impacts are?

Like, logically, you'd think customers are going to have to increase wages to find people.

Maybe that limits the ability to pay higher rents on warehouses?

Obviously, things are really tight.

I'm not sure about that.

Just trying to think more of what the longer-term implications are there with the labor market.

Yes.

There are 2 kinds of effects of the labor market.

One, is the shortage of construction labor is really driving up construction costs, and therefore, we're putting pressure on rents that's unique to justify replacement costs.

So that tends to push rents up.

In terms of what customers are doing with respect to operating the buildings and the shortage of labor, actually, what we hear from them in the U.S. is that they really are having a hard time finding customers that actually -- I mean, employees that pass the drug test, which I hadn't thought about that, but apparently this opioid epidemic is quite a big factor in terms of hiring of warehouse labor.

Anyway, I think what they're doing is they're improving working conditions.

They're paying more to get labor and they're introducing more automation and because they have to.

So the business isn't going to slow down because of that.

But remember, there are a lot of things in the supply chain costs that are actually going down in terms of cost.

The cost of energy has generally been going down.

That's transportation.

That's a big component of the supply chain cost.

Interest rates are very low.

So the cost of carrying an inventory is much lower than it used to be.

A lot of retail real estate is being skipped over in terms of the supply chain through bricks and mortar jumping over to e-commerce.

So it's a dynamic mix, some costs going up, and some costs going down.

But what we are hearing from our customers, really, for the first time in my career, which is remarkable, is that they are a lot less price-sensitive on warehouse rent, which represents about 3% of their total supply chain cost, maybe 5% in some cases and -- than they have appeared to be in the past.

I mean, they're openly telling us that.

I've never heard that before.

And your last question comes from Manny Korchman at Citi.

Just looking at your supplemental here, it looks like the occupancy within your -- the largest boxes in your portfolio dipped quarter-over-quarter.

Was there anything specific going on there?

Or it might be a mix issue or something else going on?

Yes, this is Gene.

There isn't anything particular.

And that segment as you probably follow, we've been in extremely high levels of occupancy.

But when a million footer goes dark, it makes a difference.

So -- but I wouldn't read anything into this.

Okay.

Thank you, Manny.

That was the last question.

We really appreciate your interest in the company, and look forward to seeing many of you in Dallas again, I guess, pretty soon.

Take care.

Thank you.

Ladies and gentlemen, this concludes today's conference.

Thank you for participating.

You may now disconnect.