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Prologis (NYSE:PLD)

Q4 2012 Earnings Call

February 06, 2013 12:00 pm ET

Executives

Tracy A. Ward - Senior Vice President of IR & Corporate Communications

Hamid R. Moghadam - Chairman of the Board, Chief Executive Officer and Member of Executive Committee

Thomas S. Olinger - Chief Financial Officer

Eugene F. Reilly - Chief Executive Officer of the Americas

Gary A. Anderson - Chief Executive Officer of Europe and Asia

Michael S. Curless - Chief Investment Officer and Chairman of Investment Committee

Analysts

John W. Guinee - Stifel, Nicolaus & Co., Inc., Research Division

James C. Feldman - BofA Merrill Lynch, Research Division

David Toti - Cantor Fitzgerald & Co., Research Division

Michael Bilerman - Citigroup Inc, Research Division

Craig Mailman - KeyBanc Capital Markets Inc., Research Division

Brendan Maiorana - Wells Fargo Securities, LLC, Research Division

George D. Auerbach - ISI Group Inc., Research Division

Michael W. Mueller - JP Morgan Chase & Co, Research Division

Thomas C. Truxillo - BofA Merrill Lynch, Research Division

John Stewart - Green Street Advisors, Inc., Research Division

Ross T. Nussbaum - UBS Investment Bank, Research Division

Michael J. Salinsky - RBC Capital Markets, LLC, Research Division

Jeffrey Spector - BofA Merrill Lynch, Research Division

Operator

Good afternoon, everyone. My name is Tracy, and I will be your conference operator today. At this time, I'd like to welcome you all to the Prologis Fourth Quarter 2013 (sic) [2012] Earnings Conference Call. [Operator Instructions] Thank you. I'd now like to turn the call over to our host, Ms. Tracy Ward, Senior Vice President of Investor Relations. You may begin your conference.

Tracy A. Ward

Thank you, Tracy, and good morning, everyone. Welcome to our fourth quarter 2012 conference call. The supplemental document is available on our website at prologis.com under Investor Relations. This morning we'll hear from Hamid Moghadam, Chairman and CEO, who will comment on the company's strategy and market environment; then from Tom Olinger, CFO, who will cover results and guidance. Additionally, we are joined today by members of our executive team, including Gary Anderson; Mike Curless; Nancy Hemmenway; Guy Jaquier; Ed Nekritz; and Gene Reilly.

Before we begin our prepared remarks, I'd like to quickly 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 performance, and actual 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. I'd like to also state that our fourth quarter results, press release and supplemental do contain financial measures such as FFO, EBITDA that are non-GAAP measures and, in accordance with Reg G, we have provided a reconciliation to those measures. [Operator Instructions]

Hamid, will you please begin?

Hamid R. Moghadam

Thanks, Tracy. Good morning, everyone, and welcome to our fourth quarter call. A significant milestone because it marks our first full year operating as a new company.

As you know, at the outset of the merger, we put together an ambitious plan to drive our path for the first 10 quarters as a new company. The purpose of this plan was to build a strong foundation for growth into the future. Today, we're 6 quarters into that plan, and I'm pleased to say that we've outperformed our own high expectations.

Let me take a few moments to review the highlights of our progress. Of the 4 priorities, perhaps the most central to the plan was our decision to realign our portfolio with our investment strategy. Because in many ways, the other priorities follow from this one. We're ahead of plan in terms of focusing our presence in the global markets. This priority contemplated $2.9 billion of dispositions during the course of the 10 Quarter Plan. Today, we're 80% complete, with $2.3 billion of sales at an average cap rate of 7.1%. The dispositions have occurred predominantly in secondary markets, increasing our overall percentage of assets in global markets from 79% at the merger date to 85% today, well on our way to achieving our target of 90% in the future.

Given the number of transactions over the past 18 months, the market has clearly spoken that there is no shortage of demand for high quality industrial real estate. Importantly, we sold properties at prices in line with values embedded in our internal NAV analysis.

On the deployment front, we started more than $1.5 billion of new development at an average yield of 7.9% and a value creation margin of more than 18%. These starts represent a 50% increase over the last year, with a record 57% of them in build-to-suits. In the process, we were able to monetize about $400 million of our land bank.

We've also exceeded our target for our second priority which was to streamline our Private Capital business. Our 10 Quarter Plan contemplated the rationalization of 4 funds. And to date, we've liquidated or restructured a total of 8 funds. At the same time, we're growing our Private Capital business through the formation of new vehicles and raising capital for our existing funds. We exceeded last year's record and raised $1.9 billion of new equity. A big part of this new business was the 50/50 joint venture with Norges Bank Investment Management that we announced in December. We're excited about this new relationship with such a highly regarded investor and expect to close the transaction in March.

Shifting over to Asia, we selected a J-REIT as the optimal structure for capitalizing our Japan operating platform. We're very pleased with the level of interest and demand for the IPO, which priced earlier in the week at the top of its filing range and will close next week. With these 2 major priorities behind us, we will turn our emphasis to growing our Private Capital platform by raising additional growth capital within existing funds and ventures.

Growing levels of investor interest in industrial property is being met by a dearth of stable operating platforms and experienced management teams. As an owner/operator with global capabilities across a full range of risk-return strategies, we're well positioned to take advantage of this trend.

Our third priority was to strengthen our financial position. And in this regard, we expect to get significantly ahead of plan following the closing of our J-REIT and Norges transaction. Tom will go into the details of this in his prepared remarks.

Our fourth and final priority has been to improve the utilization of our assets. Occupancy since the merger date is up 330 basis points to 94%, very close to its long-term average of 95%. Our leasing teams around the world did an outstanding job last year. We set records for annual leasing at 145 million square feet; and for the quarter with 40 million square feet. In the U.S., we're continuing to see considerably stronger demand for our spaces under 100,000 feet. Occupancy in these smaller spaces was up 140 basis points in the fourth quarter and up 200 basis points year-over-year. This segment is closely tied to the recovery in the housing market, where we expect demand to increase into the foreseeable future.

Now I'd like to shift gears and offer some brief comments on the key demand drivers for our business. The recovery in the industrial real estate market continues around the globe. All signals point to a positive future for our sector. For example, the IMF is forecasting global trade growth at 3.8% for 2013 and even stronger in 2014. Improving industrial production and new goods orders also indicate strengthening economic growth. U.S. inventories have now been growing for the last 11 out of 12 quarters and are almost back to their precrisis level. We expect further rebuilding of inventory this year that will surpass the previous peak. This is not surprising, given the fact that the U.S. population has increased by 12 million in the past 5 years. We're forecasting 150 million square feet of net absorption in the U.S. in 2013. This may prove conservative as it doesn't factor a strong recovery in housing or the strength we saw in the fourth quarter.

In Europe, net absorption continues to be positive and has been since we began collecting the data series in the first quarter of 2011. Take up also remains well above its long-term average. Supply of Class-A product remains constrained in both Japan and China. We expect the reconfiguration of supply chain in Japan and growing consumption in China to continue to drive demand for our product in the long term.

In summary, strengthening demand in the U.S., Europe and Asia, together with low levels in new construction, is having a positive impact on market rents. Recovery in rents has taking hold in most global markets and is now spreading to regional markets.

With that, let me turn things over to Tom.

Thomas S. Olinger

Thanks, Hamid. This morning, I'll cover 2 topics. First, our fourth quarter and year-end results; and second, guidance for 2013. So let's look at our results. Core FFO for the fourth quarter was $0.42 a share and for the full year 2012 was $1.74 a share. Net operating income was stronger than we expected, driven by higher occupancy and development leasing. This was partially offset by higher G&A expenses due to accruals for our compensation plan as a result of an increase in our stock price and our accomplishments for the year.

Turning to our operating portfolio, occupancy at quarter end was 94%, up 90 basis points from the third quarter and 180 basis points year-over-year, setting leasing records for both the quarter and the year as Hamid mentioned. Leasing activity during the fourth quarter was strong across all space sizes. At year end, our spaces over 0.5 million square feet were 100% occupied, and spaces over 250,000 square feet were 98.5% occupied, while small spaces were at 90%.

GAAP same-store NOI for the fourth quarter was up 0.1%, bringing the full year to 1.3%. GAAP same-store in the fourth quarter was essentially flat as a result of lower-than-normal operating expenses in the fourth quarter of 2011. On an adjusted cash basis, same-store NOI was up 0.8% for the quarter. Rent change on rollovers decreased 2.4% for the quarter. The decline was primarily driven by European regional markets where leases were signed at the high point of the prior cycle. Looking at the Americas, rent change was effectively flat in the fourth quarter, down only 0.6%. Rent change is continuing its upward trend, and we expect positive rollover in 2013.

Turning to our capital deployment, we had contribution and dispositions of $1.3 billion in the fourth quarter, with our share of this activity at $1 billion. We made significant progress in the past few months on our asset realignment strategy, with the formation of the Norges venture and the launch of our J-REIT. While the Norges venture hasn't closed, it is impacting our Q4 net earnings. Therefore, it's important to understand the whole picture when both of these transactions are completed. The net effect of these 2 transactions is an overall net book gain of more than $165 million and a modest increase in our fourth quarter NAV using current FX rates.

Let me walk you through the specifics. First, we anticipate the J-REIT will close next week. Through the contribution of $1.9 billion of stabilized assets, we expect to recognize a book gain of more than $300 million at today's FX rate. This gain is based on contributing an 85% interest in the assets to the J-REIT as we will retain a 15% interest in the entity.

Second, we expect the Norges venture to close in March. The European portfolio is primarily comprised of the former PEPR assets, but also includes some wholly owned assets. The former PEPR assets were contributed to the venture at a value effectively equal to our tender cost to acquire the additional PEPR interest. For the balance sheet assets, we recognized an impairment of approximately $135 million based on the plan contribution value of these developments. About 75% of the impairments relate to the Czech Republic and Spain. These properties were developed by us and on average had a construction start date in the first half of 2008, the peak of the prior cycle. Keep in mind accounting rules require us to recognize the impairment as if we sold 100% of the assets to the venture. However, we will retain a 50% interest and expect the asset value to appreciate over time.

To sum up, we expect to recognize a net gain of over $165 million. And taking into account FX, a modest increase in NAV from these 2 transactions. Additionally, by electing to retain a 50% ownership in our Norges venture, we will participate in the recovery of asset values in Europe, which we think will be significant.

Moving to deployment and acquisitions, development starts increased significantly in the fourth quarter, ending the year at $1.5 billion. We're continuing to see more development opportunities. And as we previously discussed, our land bank is a competitive advantage. During the quarter, we conducted a thorough review of our land bank to refresh both valuation and our intended strategy.

Let me give you some color on this analysis. Our conclusion is that our global land bank has a market value above its book value as of year end and can be divided into 2 segments. First, there are strategic landholdings located in global markets with a book value of $1.7 billion that we believe have a market value of approximately $2 billion. Second, the remaining $200 million of land is not strategic that we intend to sell in the near term. It is on this portion that we recognized a noncash impairment charge of approximately $78 million. The bottom line is we think we can create more value by selling these parcels and reinvesting the proceeds into our global markets. As you know, GAAP accounting doesn't provide for land values to be written up. It does require impairments for planned land sales with projected book losses. So when you look at the land bank in aggregate, we believe the market value exceed the book by more than 10% or by over $200 million on a net basis after the impairment.

On the capital markets front, during the quarter, we completed more than $1.1 billion of debt financings, refinancings and paydowns. On a look-through debt basis, it decreased by $800 million, and we ended the year with 43.9% leverage. We expect the Norges and J-REIT transactions will reduce our leverage further to about 37%.

Now turning to guidance for 2013. For operations, we expect 2013 GAAP same-store NOI [growth] to range between 1.5% and 2.5%. Given the disproportionate level of lease roll in the first quarter, as well as the seasonal nature of month-to-month leasing, we expect occupancy to decline in the first quarter then trend higher and reach between 94% and 95% by year end.

For FX, our guidance assumes the euro at USD 1.35 and the yen at JPY 92.

On the expense side, we expect net G&A to be $220 million to $230 million.

For capital deployment, our 2013 forecast is between $1.9 billion and $2.4 billion. This deployment includes $1.5 billion to $1.8 billion of development starts, with our share at approximately 75%. We have great visibility into our development pipeline and are off to a good start. Our forecast also includes acquisitions of $400 million to $600 million, with our share at about 35%.

Turning to contributions and dispositions, we expect $7.5 billion to $10 billion in 2013. Our share of the contribution and disposition proceeds will be approximately 60%. Over half of the contribution and disposition forecast relates to Norges and J-REIT transactions, which we expect, again, will complete in the first quarter.

Now for our core FFO guidance for 2013. We expect full year core FFO to be in the range of $1.60 to $1.70 per share. As a reminder, our core FFO excludes any gains or losses from disposition and contribution activity. We believe the appropriate 2012 run rate to which our 2013 guidance should be compared is $1.68 per share, which represents our Q4 2012 result annualized. This is also consistent with our full year 2012 result of $1.74, less the onetime tax benefit we recognized in the third quarter.

The midpoint of our 2013 guidance is $1.65 and represents a $0.03 year-over-year decrease versus the 2012 run rate. The decline is driven primarily by the initial dilution from the timing and associated friction of redeploying the significant proceeds from our contribution and disposition activity. Relative to this, the average yield on contributions and dispositions is about 6.8%, while the average yield on our use of proceeds is approximately 4.2%, consisting of debt repayments, preferred redemptions and capital deployment. This dilution is largely offset by new Private Capital revenues, increased NOI from development stabilization and same-store growth and lower taxes from structure efficiencies. The timing of contributions and dispositions obviously has a significant impact on core FFO. As we previously said, the Europe recapitalization is happening earlier than what our original plan contemplated. If the Norges venture closed in the fourth quarter of 2013, our guidance would increase by almost $0.08. We think our quarterly core FFO run rate by the end of 2013 should be at or above $0.42 a share. So by the end of 2013, we will fully recover our fourth quarter 2012 run rate, yet with significantly lower leverage and FX exposure.

In closing, I'm very pleased with our results this quarter and our progress related to our 10 Quarter Plan. As we've been saying for some time, this is an asset-driven plan, and our achievements will significantly improve our cost structure, our balance sheet and our liquidity. To put this all in perspective, by the end of 2013, we will have reduced our leverage, including preferreds from 50% at the merger to 37%, reduced our non-USD equity exposure from 55% at the merger to less than 35% by year end, all while enhancing the location, age and quality of our portfolio. While we have a little further to go to reach our long-term target for leverage and foreign currency exposure, we're well positioned to take advantage of opportunities to continue to grow our company strategically.

With that, I'll turn it back to Hamid.

Hamid R. Moghadam

Thanks, Tom. Before we open the call to questions, let me close with the key takeaways. We had an excellent quarter and a strong finish to the year, and I couldn't be more proud of how our teams have executed. I also think it's easy to lose sight of the magnitude of these accomplishments.

As a quick recap, since the merger we have sold $2.3 billion of assets; realigned over $12 billion -- that's $12 billion of fund assets; raised $2.4 billion in new private capital; increased portfolio occupancy by 330 basis points; started $1.9 billion of developments, with an average margin of 19%; and reduced our leverage by 1,300 basis points post the Norges and the J-REIT transactions. These efforts have allowed us to build a strong foundation for sustainable growth and to reach our goal of being a blue chip REIT as we discussed at our investor forum. We have the portfolio, the customer relationships, the balance sheet and most importantly, the team to capitalize on market opportunities by leveraging our scale and global footprint. As always, we'll do this in a responsible manner.

We'll now open the call for your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of John Guinee with Stifel, Nicolaus.

John W. Guinee - Stifel, Nicolaus & Co., Inc., Research Division

John Guinee here. Hamid or whomever, looking at Page 29, which is your development story, it looks to me like you've got about 10 million square feet -- I'm sorry, 11.2 million square feet in the U.S. alone at a development number of somewhere between $73 and $76 a square foot, which strikes me as fairly high for bulk industrial. What exactly are you building and where are you building it to come up with $73 to $76 a square foot?

Hamid R. Moghadam

John, I'll have Gene answer that.

Eugene F. Reilly

Sure John. I'm actually having trouble reconciling the page number, but as to the cost per square foot, these are driven primarily by a lot of starts in the Los Angeles market. That is not an usual number at all. And if you're looking at an Americas number, it is going to incorporate Brazil. John, I'm going to continue. So in Brazil, our development costs range from $95 to over $100 a square foot, so it's a real mix issue. And if you want to look at the downside, we can certainly develop, for example, a large floor plate build-to-suit in the, call it, low to mid-40s if you're in a market like Dallas, for example. So there's a pretty broad spectrum there.

Operator

Your next question comes from the line of Jeff Spector with Bank of America Merrill Lynch.

James C. Feldman - BofA Merrill Lynch, Research Division

This is Jamie Feldman here with Jeff. I guess my question is more on guidance. I was hoping you could provide a couple of details, which are, what's the cash same-store NOI growth rate? What is the AFFO based on your guidance range? And then, I guess, bigger picture on the development or on the dispositions, kind of how should we think about that getting from the $7 billion to $10 billion, kind of what would you be selling? What kind of pricing and what's the appetite?

Thomas S. Olinger

Okay. Jamie, this is Tom. I will take those. So first on cash same-store NOI, I would expect cash same-store NOI to be at the high end of our GAAP range. We've clearly been trending cash higher than GAAP same-store, which you would -- which is consistent with this point in the cycle. Next on AFFO, AFFO for 2012 will come in right in about the low 90% range. I would expect the same range for 2013. On the dispositions side, when you look at dispositions for the year -- we'll step back, when you look at contributions and dispositions for the year with the guidance, the midpoint is just under $9 billion. And when you think about the Norges and J-REIT transactions, that's a little over $5 billion. So you're left with about a little over $4 billion left. And when you look at the buckets of what's left, it's really 3 things. One, there are about $1.3 billion of asset repositioning. So selling out of non-core markets and assets. There's about $1.5 billion of contributions into existing funds. A lot of that's in Europe, but also in platforms in Mexico and Brazil. And we have about a little over $2 billion of what I would call fund rationalizations, so these are just continuing asset sales out of existing funds that are either -- that we're rationalizing.

Operator

Your next question comes from the line of David Toti with Cantor Fitzgerald.

David Toti - Cantor Fitzgerald & Co., Research Division

Just a couple of questions, and I'm sorry if I missed this, but did you go into detail about the impairments that were taken in the period?

Thomas S. Olinger

We did.

David Toti - Cantor Fitzgerald & Co., Research Division

And is there -- I guess, it's a fairly recurring event at this point, and I guess, what's your sentiment relative to the asset base and potential impairments going forward? How that impacts your decisions on future contributions? I'd just like to get more of an understanding about the nature of the accounting and the strategic decisions behind that, those kind of charges.

Thomas S. Olinger

This is Tom, I'll take that question. I believe the impairment is over. We don't see any impairments going forward really at all. What's driving this is clearly our change of intent on a very small portion of our land bank, which we believe we can redeploy that capital and quite frankly, generate a much better return by redeploying that capital, so that's on that point. And on the European asset side, these were assets we had planned to hold for the long term, very good assets, but as we talked about in my prepared remarks, these assets were developed at the peak of the cycle. But the important thing is, we had to pick up 100% of that value change even though we only contributed 50% of the asset into the venture. I mean, that's just the way the accounting rules work. So it's a very lopsided view of what really happened, when in reality we're keeping 50% of the upside of those assets. So if -- I would call it accounting gymnastics and don't expect to see much, if any, of that going forward.

Hamid R. Moghadam

And I would question that characterization of, this is a recurring event. I think it's the first time we've done it as a merged company, and it was after a strategic review of our land assets in Europe primarily.

Operator

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

Michael Bilerman - Citigroup Inc, Research Division

Tom, just sticking with you just in terms of peeling back the onion a little bit on sources and uses. So just at the midpoint, you're going to generate $5.25 billion of cash from the sales, then you talked about that being at about a 6.8% cap rate. And then as a use of the cash at a 4.2% for debt repayment, preferred and sort of capital deployment. And I'm wondering if you can just sort of go through the amounts that you're using for each and the timing because I assume it is going to be bumpy throughout the year as the cash comes in, but you won't be able to use that cash immediately, and so maybe just walk us through some of that. And then you talked about new private capital and lower taxes, but you didn't quantify the change of those line items year-to-year, and so if you can go through that as well that would be helpful.

Thomas S. Olinger

Okay, I will try to address all of that. So you're right. When you look at the midpoint of our contribution and disposition guidance, it's about $5.25 billion, but for round numbers, just call it, $5.5 billion. And our share of deployment is about $1.4 billion. When you look at the debt side, which again we think will be around 4.2% blended yield on what we could get after, there's several different components of it, and I'll try to give you the bigger pieces. Number one, the biggest piece is debt transfer. That's about $1.1 billion. So when you think about the Norges transaction, debt going, transferring from our balance sheet into the venture, although it's very small. We also have contributions in Europe where debt is getting transferred to the funds. And when you think about the J-REIT transaction, where we're extinguishing debt in connection with that transaction, so that's all about $1.1 billion. There's the convertible debt of just under $0.5 billion that matures. There's bonds that mature of about $400 million. And then there's about $700 million of other debt that some of it's maturing and some of it's debt we think we can get after that matures beyond 2014 with minimal friction. The -- one more piece would be the preferreds, as you mentioned. We can redeem all but one series of our preferreds. That's just under about $0.5 billion. And then the balance of that, to finish it out, would be on our line. So when you look at the blended yield on all of that activity, on all of that reduction of leverage, that's about 4.2%. And you're right, from a timing perspective, this will be lumpy as we look through half the quarters of 2013. Now clearly, with the Norges and the J-REIT transaction happening mid-to-late in the first quarter, that will clearly have impacts throughout the year. Because when you step back, there is really a timing difference here, as we said in my prepared remarks, to really put this capital back to work. And although we can reinvest in very, very profitable development activity, there's just a timing gap between as we're constructing those assets, the only real yield we get is cost to carry, which is about 4.5%. We don't get that yield out of our pipeline.

Operator

Your next question comes from the line of Craig Mailman with KeyBanc.

Craig Mailman - KeyBanc Capital Markets Inc., Research Division

Jordan Sadler's on with me as well. Can you guys just maybe address, I guess, last quarter you kind of commented that you think rent spreads were going to start to turn negative here. I know you had mentioned it's going to bounce around a bit, but the negative 2.4% this quarter is a little surprising. Just what are you seeing on that front? Do you think it's early in '13 or is that getting pushed out, the expectation?

Gary A. Anderson

Craig, it's Gary. As we said last quarter and most quarters, this is going to bounce around on a quarter-to-quarter basis, it's a bit volatile, but I think the important thing for you to do is to look at the trend line on a year-to-year basis. And that trend is absolutely undeniable, and it's positive. So we're definitely trending in the right direction. We would fully expect that we'll see positive rent change on rollover for the full year 2013. If you want to dig into Q4 specifically, Tom said at the outset that it was related to Europe leasing, and it was. I'll just remind you, for the quarter, we had record leasing for the company at 40 million square feet. We had record leasing for Europe at about 12 million square feet. When you pull back the onion with respect to Europe, it's actually pretty interesting, the composition of the leasing. 70% of the leasing was in France, Germany, Poland and The Netherlands, and that shouldn't surprise you. Those are our big markets. But 20% of the leasing was in Slovakia, the Czech Republic and Spain. Slovakia may not surprise you, the Czech Republic and Spain should. Peel the onion back even a little bit further and it gets even more interesting. In the Czech Republic, we did leasing in Uzice, which is -- the market's about 30 kilometers north of Prague. In Spain, it was in [indiscernible] which is sort of a secondary market and [indiscernible] we're actually seeing leasing. So the long and the short of it is, we're seeing leasing in non-core submarkets that we haven't seen really for the past 3 years. And those markets are rolling off peak rents. So again, while we're seeing somewhat higher rental rolldowns in Q4, I think we're seeing greater activity in the non-core markets. And I'll take the NOI from those non-core markets as opposed to the quarter-to-quarter rent change any day.

Operator

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

Brendan Maiorana - Wells Fargo Securities, LLC, Research Division

I wanted to go back into the evaluation for the assets that were sold or to be sold in the Norges in Europe and the J-REIT. I think in the prepared remarks you guys mentioned that they were above the internal values within the NAV, but as outsiders as we look at it, the cap rates appear higher than what we'd use for -- where those regions would come out at least on an average basis. So I'm wondering what is -- if these values are above the internal NAV, first, is that excluding the pickup that you get in management fees? And second, what does that suggest about the values or the appropriate cap rates for the remainder of the portfolio that will be in both in Europe and in Japan?

Hamid R. Moghadam

So let me give you a global answer on that. I think the Japan, the IPO has to be priced at NAV by definition, which is based on appraised values, and those are actually within 10 basis points of our cap rate to the good. In other words, the appraised values were at a 10-basis point lower cap rate than what internally we had in our model. So that's pretty simple and actually you'll have to wait to see where the thing trades. But I think the indications of what the valuations are going to be are going to be pretty strong at the public level. So that's pretty simple to talk about. In Europe, it's a pretty simple math. We actually end up buying the bulk of what we recapitalized in this transaction through a tender process at PEPR. And basically our goal was not to make a spread on the deal or anything like that. We just wanted to get it from one format that was not right into another format that was right. And we did that on a breakeven basis a year sooner than we wanted to. Now you could argue that we could have hung in there and done it at 50-basis point lower cap rate and maybe we could have. But we chose to actually break even on that transaction and establish a very new major relationship with a major investor, and we kept 50% of the portfolio that we get to write up, plus a promote on the other 50% that we sold. So I think what it says about cap rates is that it was a really good transaction for the company from a capital allocation point of view. And if you take all of that and compare it to the range of cap rates that we have used in our investor presentations, and you -- particularly blended in with the dispositions, which are off the bottom of the portfolio, we're selling you our least desirable assets, actually you would conclude that we are -- we were a little low on our NAVs before and the market -- based on the market speaking, we should be a little bit higher than what we had before.

Thomas S. Olinger

And Brendan, to answer the second part of your question regarding management fees, yes, the increase in management fees from the formation of those new ventures is in our NAV calculation.

Operator

Your next question comes from the line of George Auerbach with ISI.

George D. Auerbach - ISI Group Inc., Research Division

Just one question for Tom. The trailing 4 quarter of CapEx as a percentage of NOI has been ticking up through the year. I guess it makes sense given how much leasing you're doing, but with the portfolio at 94% occupied, where do you think that ratio goes in 2013?

Eugene F. Reilly

I'm going to take that, this is Gene. And we think that as you look at 2012 going into 2013, these overall numbers will stay the same. You accurately point out that substantial leasing activity is going to move the CapEx number. But if we break this down a little bit and just look at property improvements, for the last couple of years, we've been really ticking along at about $0.05 per square foot per quarter of property expenses agnostic of leasing. And we think that's going to continue at that rate, so we do not see uplift there. With respect to the cost to lease our space, that's held pretty steady. If you look at it on a constant basis, which should be on a kind of cost per square foot as you do leasing, and that's -- it's right around $1.37. So again, we see that as being fairly steady. And frankly, I'm really happy about that because we're doing more small tenant leasing in the last couple of quarters, and those generally have higher TIs. So looking at the trailing 4 quarters numbers, the way we've done this book, it's going to take another few quarters for those numbers to sort of rationalize. If you look at the book last year, we didn't even start doing that until the fourth quarter. So we got to digest this and run it through a little bit further. But I would say, you get a 13.9% number there for this quarter, that's going to go down because that's pushed up by the high velocity of leasing. So I'd say it'd be in the 12s, but let it play through for a couple of quarters.

Hamid R. Moghadam

George, I wouldn't look at those numbers quarter-by-quarter. I look at them year-over-year because there are seasonality and all kinds of things. And really the right time to look at these is where the different segments in terms of size of portfolio are about the same level of leasing. We're basically out of big space. I mean, we have 100% occupancy on spaces over 0.5 million feet. 1.5% on spaces over 250,000 feet and 10% in the small spaces. So most of the new leasing that's going to be done is going to be the small spaces, and those are going to be more expensive.

Operator

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

Michael W. Mueller - JP Morgan Chase & Co, Research Division

Just real quick, if we're looking at the sequential occupancy increase into Q4, was all that coming from leasing or was there any, I guess, significant impact from asset mix change?

Thomas S. Olinger

There's no impact from disposition activity.

Michael W. Mueller - JP Morgan Chase & Co, Research Division

Okay. And real quick, in terms of the build-to-suit or in terms of the guidance for development starts, can you talk about what the percentage of build-to-suits is in that mix?

Michael S. Curless

This is Mike. Last year, we enjoyed a very high build-to-suit percentage, as Hamid referred to, at 57%, and we would expect on a going forward basis that to more level off approximately more in the 50/50 range going forward. We're certainly very optimistic about our build-to-suit pipeline when you consider the U.S. pipeline is as strong as we've seen in some time. We're seeing some pickup in Europe, and we're seeing our customers, potential customers in those pipelines changing some of their requirements with more of a focus on what we would consider global markets as they're intending to be in more major population centers to serve their customers potentially in one-day delivery cycles, and we think that's going to bode very well for our build-to-suit prospects in the future.

Operator

Your next question comes from the line of Tom Truxillo with Bank of America.

Thomas C. Truxillo - BofA Merrill Lynch, Research Division

Tom, I appreciate your comments on where you think leverage is going and on walking us through the sources and uses on how you get there. But given how the Norges JV is going to be structured, essentially debt free, it seems like at least the timing of how that leverage is going to be split between your wholly owned and your joint ventures, has changed a little bit. I mean, you had the goal of wholly owned being 25%, JV is 40%. It seems like those 2 ratios are going to be maybe inversed here for a while. Can you talk about the timing of that? And do you still plan to get wholly owned assets to a 25% leverage number?

Thomas S. Olinger

Yes, I think the -- yes, we will get the wholly owned to 25%. And I think the reality is that our joint ventures will actually be less than 40% when you really look at it long-term because we have several ventures now, the Norges venture, the Allianz venture, that are using little or no leverage. Brazil, no leverage. So I think the reality is 25%, yes, we're going to hit that number on a wholly owned basis and my guess is our -- the JV is actually lower than 40% what we said long term.

Operator

Your next question comes from the line of John Stewart with Green Street Advisors.

John Stewart - Green Street Advisors, Inc., Research Division

I've got one for Hamid and 2 quick housekeeping items for Tom. Hamid...

Hamid R. Moghadam

Uh-oh, yellow flag.

John Stewart - Green Street Advisors, Inc., Research Division

I'll try to keep it short. First of all, Hamid, congratulations on all you have been able to accomplish since the last call, particularly in Japan and Europe. A question on Japan. What is the rationale for essentially leaving half of the portfolio on balance sheet and how did you arrive at what went into the J-REIT and what stayed on balance sheet? And then for Tom, just following up on the accounting treatment for the European JV, will you initially consolidate that? Just curious about when you're referring to the debt transfer. And then lastly, on G&A I think you gave us a net number, what would the gross number be? And I presume at this point that all merger integration costs will have been realized. Is that right?

Hamid R. Moghadam

Okay. I'll answer the accounting questions and Tom can -- let me answer your question, first of all, thank you for your congratulations. But I get to talk about it, the team gets to do all the hard work. So we appreciate it on behalf of the team. Secondly, the rationale was pretty simple. We think there is a tremendous upside in values in Europe. And we were able to recapitalize PEPR, which was the primary component of this and bring it in-house basically at a pretty good value, and that's essentially where we recapitalize it with the Norges transaction. So we like -- originally, we were going to do an 80/20 deal, but we looked at these values and we said, this is the best place we could have our capital invested over the next couple of years. So we like owning 50% of this portfolio. And if you really look at the economics at that 50 -- on a 50/50 basis, plus a promote opportunity, we think in the next 3 years, we could have maybe 50% of the upside economics of this deal and meet our objectives. So that was pretty easy. Now on the J-REIT side, I think you asked about that too. On the J-REIT side, the selection of the portfolio was pretty easy. Those were the assets that were essentially unencumbered and stabilized on the balance sheet that were ready to go, and in the pipeline for the J-REIT, there are a further 8 properties that are under development or in late stages of development, actually pretty well leasing up. And 2 assets from the old AMB portfolio that have some secured debt on them that needs to get resolved. So of those assets, when they're ready to go, we're hoping that the J-REIT will transact on those assets as part of its redesignated portfolio. So I think that answers all of your questions.

Thomas S. Olinger

John, I'll tick through yours. Norges will be on the equity method of accounting, as will the J-REIT. Merger expenses were done, happy to close the cover on that book, won't have merger expenses in 2013 related to that transaction. And on a G&A perspective, gross G&A, of course just excluding property management or Private Capital, which is the way we look at G&A. Gross would be between $290 million to $300 million for 2013 on a gross basis before capitalization.

Hamid R. Moghadam

Yes. The only difference between the gross and the net in our vocabulary is basically what's capitalized into development. And that number will probably increase over the next couple of years, the portion that's capitalized will increase.

Thomas S. Olinger

Just given our development activity.

Operator

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

Ross T. Nussbaum - UBS Investment Bank, Research Division

A couple of questions. I'm actually looking at the footnotes in the back of the supplemental, and 2 things caught my eye. The first is, there's been about $220 million spent on merger, acquisition and other integration expenses, including $28 million this last quarter. How much more should we expect in 2013? And then the table that's sitting right next to it, the free rent number, almost $17 million in the fourth quarter. Can you give us a sense of how many of the leases that are getting signed have a free rent component and where should that number trend over the next year?

Thomas S. Olinger

Okay. Ross, no merger expenses in 2013. We're done with merger expenses after 2012.

Eugene F. Reilly

On the free rent, I mean, I hesitate to tell you where that number is going to go, but in general if you look across the geographies, concessions are declining and that includes free rent. And frankly, I'm struggling to think of a place where that's static. So the concessions are declining. So we would expect to see free rent lower in the future.

Operator

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

Michael J. Salinsky - RBC Capital Markets, LLC, Research Division

Hamid or Tom, when you gave your presentation back in the fall, your stock was trading at $34, trading close to $40 now as you look at your sources and uses for 2013 and beyond. How do you think about common equity at this point?

Hamid R. Moghadam

I have never answered that question in a good way. So I'll take the fifth on that completely. But let me really get to the essence of your question, which is kind of leverage and where it's going and all that. So after Norges and J-REIT, the company will be 37% levered. We think of the 30% additional interest that we're keeping in the Norges transaction as a temporary investment. Hopefully one that we will liquidate, if you will, in the next 3 years for the terms of the agreement that we have. That is about 2.5 to 3 points of leverage. We also have some convertible preferreds, just under $500 million of them, that are technically expiring in 2015. We might be able to get at that a little bit earlier. Who knows? I mean, you would think those guys would want to convert at some point given where the strike prices are. That's another 1.5, 2 points of leverage. So I mean, based on what we've done, assuming that we don't do anything else, and we plan to do plenty of other things, our leverage will be in the low-30s. So we have a pretty good path to reducing leverage. So I know I didn't quite answer the question you asked, but I think I answered the question that I could answer.

Operator

Your next question comes from the line of Jeff Spector with Bank of America Merrill Lynch.

Jeffrey Spector - BofA Merrill Lynch, Research Division

Just wanted to ask about the U.S. housing recovery and how you're thinking about that this year. At the prior peak, what was the percent of the home oriented tenants in your portfolio and where are you today and what are you thinking about that going forward?

Eugene F. Reilly

Jeff, this is Gene. Let me take a stab at that. Let me give you a general answer first. With respect to housing, we've been talking about this recovery for a while. And what we have in our forecast is a continued sort of modest recovery in home building in the U.S. So as I look at our U.S. operations, we have upside potential if this recovery really picks up steam. And there's an awful long way to go. I mean, we were at 1.8 million in annual starts of homes at the peak.

Hamid R. Moghadam

Yes, that's not going to happen.

Eugene F. Reilly

I don't think that's going to happen. But we were down to 500,000, 600,000 and now we're trending up 700,000. And we have upside in our numbers if that really picks up steam. And if the recovery completely stalls and reverses, then we probably have downside. The question you asked about what percentage of our tenants are related to home building, that's probably a pretty big number. But it has a bandwidth to it. In other words, you don't have a lot of tenants who are 100% necessarily, but you have many tenants that are generally related to it. And that's probably something we can work on for you guys to get some more detail. But if we look at what our leasing activity is shaping up to be in the last quarter, this current quarter, more and more demand from the carpet guys, the tile guys, appliance sales are up. And in markets like Las Vegas or Phoenix that were really, really hurt, we're finally seeing some good demand. And that's why you're seeing the occupancy levels in the smaller spaces go up. But a little more of a complex answer to be precise in the numbers. But I am personally quite optimistic that this trend's going to accelerate.

Operator

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

Michael Bilerman - Citigroup Inc, Research Division

Yes, just 2 quick follow-ups, one was just in terms of debt to EBITDA, just thinking about leverage in a different way. It would appear as though once you stabilize the existing developments underway plus the developments you're going to start in '13, and you sell all the assets you plan to sell this year, and you have the growth in EBITDA just from the increase in same-store, that you're probably in the low-7s debt to EBITDA, so I just wanted to make sure that we're sort of on the same path and the same page. And I think you've talked about a target of 5 to 6x. It would seem as though, I guess, some of these other sales will eventually get you that goal. But I want to make sure we're thinking about it the right way. And the second one is just in terms of spend. Tom, you talked about $1.4 billion of deployment this year, but I assume on those developments, you're not spending all of it this year, and you have $800 million left to spend on the existing pipeline, so call it a $2.2 billion total commitment that you've put out there. How much of that actually gets used in 2013 as we think about the sources and uses? And I think you forgot to answer the question that I'd asked earlier about Private Capital contribution in the lower taxes and how much that's impacting '13 versus '12.

Thomas S. Olinger

Okay, first on the EBITDA question, you are right in the ballpark there regarding it being in the low-7s. And clearly, with the additional pieces that Hamid mentioned, that will get us down into the low-6s if not putting a 5 in front of it.

Hamid R. Moghadam

Yes. To get into the 5s, we need a more robust recovery in rents, which we'll get, but it will take a while for it to roll over through the rents. So I think we'll get there, but it's not going to be primarily because of deleveraging activity. I think if we just look at deleveraging and not a substantial growth in rents, we'll be in the low-6s, and I think we need that last little hump on rents to get into the 5s.

Thomas S. Olinger

And then Michael, on your question about deployment, you're right, we're not going to spend all of the money on our 2013 starts. The midpoint of that's $1.650 billion, but we had $1.155 billion of starts in 2012. And we're going to be spending -- what we haven't spent in '12 we're spending all of that in '13. So the numbers actually are fairly much in line with what I pointed out. So that -- the $1.4 billion I gave you is really the full spend.

Hamid R. Moghadam

Yes, but here's the math I think that you're trying to do. Obviously, we own the land. So when you guys were talking about the yield on incremental investment, you were looking at it at total investment. You got to back out the land. The yield on the incremental investment is much higher and the land is for free. Actually, it's negative in terms of what it costs us.

Thomas S. Olinger

And then Michael, I think your last question was regarding Private Capital and deferred taxes with the contribution. I mean clearly, we've talked about the deferred taxes, the deferred tax liabilities we have in our books, so if that was your question. When you look at the drop, we dropped deferred taxes by about $75 million from Q3 to Q4, and that was largely a result of contributions. So that balance started at about $525 million, it's down to $450-ish million now. We'll drop that number by another $260 million when we transact -- the Norges closes. So that's going to take our number down. It's going to have a 1 in front of it. And so we've really worked it down and the most important thing is, the vast majority, if not almost all that liability, was really moved from a structuring standpoint. So we didn't have to settle that obligation with the relevant taxing authorities in cash. We were able to move that liability through structuring. So and that's really important because that's often a piece people miss from a NAV perspective. They look at the NOI side of the house, but they don't look at the liability that gets moved off the balance sheet. So that's really important for you guys to look at.

Hamid R. Moghadam

And I think there was a question earlier about cap rates in Europe and all that. That in effect is a negotiating item. You can either do the deal at a lower cap rate and incur that deferred tax liability or you can negotiate a deal at the higher cap rate and transfer that liability. So we obviously reported to you the worst possible cap rate number. There's another way we could have shown it to you, which would have shown a much lower cap rate.

Operator

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

Hamid R. Moghadam

John, they got your name right, I thought you'd be there.

John W. Guinee - Stifel, Nicolaus & Co., Inc., Research Division

Oh, sorry about that. I'm sorry. I had it on mute. I think what you're saying, Tom, in this regard is that you really should look at -- or is another couple hundred million dollars of implicit or explicit proceeds on the Norges deal because the tax liability goes away or does it just get pushed down the block?

Thomas S. Olinger

Well, I think it's one and the same, right? Because when you transfer -- if we transfer that liability to an entity, which we now only hold 50%, 50% of that liability has been relieved.

Hamid R. Moghadam

It's cut in half in nominal dollars, and it's cut into a fraction in present value dollars, given that it's pushed out way into the future.

Thomas S. Olinger

But if you look at just what we completed in between -- in Q4 in Europe, as well as the Norges transaction, that's a drop of over $300 million.

Hamid R. Moghadam

It's like cash.

Operator

Your next question comes from the line of Brandon Maiorana with Wells Fargo.

Brendan Maiorana - Wells Fargo Securities, LLC, Research Division

Tom, I just wanted to follow up on the same-store guidance, the cash number, which it sounds like cash is probably 2.5%, maybe 3%, I think the high end of your GAAP number is what you said. If I look at '13, it looks like you've got some nice tailwinds from a same-store perspective, occupancy should be up year-over-year. You've got rent spreads that are getting better. You've got positive in-place annual rent bumps, and you've got that large free rent portion as it stands in your portfolio today that ought to be little down at least a portion of it during 2013. So maybe sort of plus 2.5% to 3% strikes me as a little bit conservative, especially relative to what I think was a cumulative 25% NOI growth that you guys provided back in September over the next 4 or 5 years. I'm just wondering if you could sort of lay out how '13 shakes out relative to the longer-term expectations of same-store NOI growth over the next few years.

Hamid R. Moghadam

Well, '13 would be, if you take those next 4 years. I mean, just given the nature of how this stuff rolls through the portfolio with expiration of leases, obviously in 2008 and '09, certainly in 2008, you're still rolling off peak rents, and by 2009, you pretty much got to the bottom of the market and every new lease you were doing there was at a pretty low number. So when you roll out 4.5, 5 years forward of that, by '14 it should really pick up. But we roll 15%, 20% of the portfolio in any given year. So even the market -- if the spot rents recover substantially, it still takes a while before it works through the portfolio. But our thesis, if we were doing our investor conference today as opposed to last September, I would tell you our outlook on rents would be stronger than it would have been last September. And the reason for it is that at least for the next month, the cloud on this whole fiscal cliff thing is a little bit more positive. And the tone in Europe is more positive, and we got [indiscernible] economics in Japan. So if you look at those 3 factors alone and China has definitely turned a corner, right? So if you look at those 3 or 4 political factors alone, we would have a more optimistic outlook. But the leases make it a while before it rolls over the portfolio. Let me tie this to guidance because this is really important, and you guys are going to get this, but I just want to state it. If you look at the $0.06 of the onetime tax thing last year, and you look at the $0.08 of dilution of Norges because we weren't even thinking about doing that deal until the very end of 2013 or a deal like that, that's $0.14. If you adjust the guidance by $0.14 to keep it kind of comparable, our earnings growth range at midpoint is 8% in terms of FFO per share growth over last year, and that is with significant deleveraging. I think that's pretty impressive and the primary driver of that is same-store growth. So yes, you're right. We're on that path, and I'm very optimistic about the prospects for our business.

Operator

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

Michael J. Salinsky - RBC Capital Markets, LLC, Research Division

You talked a bit about pricing in Europe for assets. Can you talk a little bit about domestically and where you expect that in '13? And also on the development side, can you talk about where you expect the development margin is for the starts that you're planning in '13?

Michael S. Curless

This is Mike Curless. I'll take the margin question first. What we saw last year, I think you saw margins in the [indiscernible] -- in the 18% range, which we were certainly happy with that. And we've mentioned on the call many times before that our expectations typically are about 10% for build-to-suit and 15% for spec. And a margin of 18% this year would definitely indicate, as Tom mentioned, that we have built-in increased land value within our portfolio. And as you look forward to next year in terms of margins, we have an expectation over time to have a little bit more of a normalization back into that 10% to 15% range as land prices continue to increase over time in terms of their market value. And in terms of pricing with respect to dispositions, given the nature of the product, type and the locations, we would expect similar results next year, but we were happy to have cap rates in the low-7s in terms of our disposition activity when you consider that we're selling older product, tuning up our investment strategy in terms of ending up with more of our assets in the global markets, we're at 85% now, up from 79% since merger. All-in, we think our disposition strategy will be similar to this year, which will really help us tune up our investment strategy.

Hamid R. Moghadam

The only thing I would add to what Mike said is that if you look at that 18% margin, it is -- given the mix of almost 60% build-to-suits, that should have been sort of 12% to 13%. So we have 5 or 6 extra points of margin easily there. And if you kind of look at land as 25% to 30% of the total cost, that tells you that the land bank is 20% undervalued, if I'm doing that math carefully, correctly, 20% to 25%. So that's one way to get too comfortable with the fact that actually I think there is NAV upside in the land bank, and I think with increasing rents that, that spread gets bigger over time, but of course, we're always buying new land and the spread on the new parcels of land will be lower.

So anyway, wanted to thank everybody for joining our call, and we look forward to talking to you next quarter. Thank you.

Operator

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

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