ProLogis Inc. (NYSE:PLD)
Q4 2008 Earnings Call
February 10, 2009; 10:00 am ET
Walt Rakowich - Chief Executive Officer
Bill Sullivan - Chief Financial Officer
Ted Antenucci - Chief Investment Office
Chuck Sullivan - Head of Global Operations.
Melissa Marsden - Managing Director of Investor Relations & Corporate Communications
Michael Bilerman - Citi
Mark Biffert - Oppenheimer
Kei Vin Kim [Ph] - Macquarie
Louis Taylor - Deutsche Bank
Jay Habermann - Goldman Sachs
Steve Sakwa - Bank of America
John Peterson - UBS
David Fick - Stifel Nicolaus
Chris Haley - Wachovia
Michael Mueller - JP Morgan
Good morning everyone. My name is Matt and I’ll be your conference facilitator today. I’d like to welcome everyone to the ProLogis year end 2008 financial results conference call. Today’s call is being recorded. All lines are currently in a listen-only mode to prevent any background noise. After the speakers presentation there will be a question-and-answer session. (Operator Instructions)
At this time, I’d like to turn the conference over to Ms. Melissa Marsden, Managing Director of Investor Relations and Corporate Communications with ProLogis. Ms. Marsden, please go ahead.
Thank you, Matt. Good morning everyone and welcome to our fourth quarter, year end 2008 conference call. By now, you should all have received an e-mail with the link to our news supplemental and our guidance for 2009, but if not, those documents are available on our website at www.prologis.com, under Investor Relations.
This morning, we’ll first hear from Walt Rakowich, CEO to comment on the progress relative to our current initiatives and the overall environment and then Bill Sullivan, CFO will cover our results, guidance and refinancing activity. Additionally, we are joined today by Ted Antenucci, Chief Investment Officer; and Chuck Sullivan, Head of Global Operations.
Before we begin the 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 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 and the risk factors in our December 30, 10-Q and our 10-K.
I’d also like to add that our fourth 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. As we’ve done in the past, to give a broader range of investors and analysts an opportunity to ask their questions, we will ask you to please limit your questions to one at a time.
Walt, would you please begin?
Thank you, Melissa. Good morning everyone. A great deal has happened since our third quarter results conference call. Many of you attended our meeting in New York last November, where we outlined our plan for de-leveraging and de-risking our balance sheet, while preserving liquidity. We’ll tough on those initiatives in progress into 2009 and intend to leave a substantial amount of time for Q-and-A. Bill will have more on our capital position, impairments and 2009 guidance in a moment.
Now since our November meeting, we’ve taken action on a number of fronts. As you know, we halted virtually all new developments starts moving forward. We also stopped all early stage development, which resulted in a reduction in future funding obligations of $444 million. We cut our dividend to an amount, which more closely mirrored our estimated taxable income, saving $290 million per year and we began to right size the company by reducing our gross G&A expenses by roughly $100 million or 24%.
Before the quarter ended, we accomplished some additional initiatives advancing our agenda further. We retired $310 million in bonds that matured in 2010. We reached a solution, which allowed for PEPR to generate cash and alleviated its future funding obligations through the sale of its PEP II units.
We entered into an agreement to sell our operations in China and our interest in our Japan funds to GIC for $1.3 billion, which also saved us $239 million of future development funding obligations and we contributed roughly $1.3 billion of properties into various funds throughout the world generating a 14.5% pre deferral and 10.6% post deferral margin. I hope you understand how focused we are. We understand we have more work to do this year, but make no mistake about it; the difficult environment has our intention.
Now, let me address the sale of our operations in China and our fund interest in Japan. This was not an easy decision. However, it was the right decision given the challenges of the current capital environment. We will miss our team in China and our departing colleagues in Japan. They’ve done a terrific job for the company throughout their years of service and we appreciate their dedication.
Now, you will note that the transaction is closed; however the funding comes in two installments. This is due to the fact that audits through December 31, 2008 have not yet been completed. We and GIC believe this is a ministerial process that will be complete as soon as possible, but no later than early second quarter. Accordingly, in order to close the deal, GIC made a substantial down payment of $500 million with the balance due on the completion of the audits.
In Q4, we took $198 million charge for the impairment associated with the China sale. We planned to book a gain of about $140 million on the sale of the Japan fund interest in 2009, as that is when the transaction closed. We also have closed our offices in India and the GCC and postponed early stage efforts in Brazil. We will evaluate re-entry into these markets at some point in the future, but for now, we are intense on strengthening our core business where we have a significant presence while mitigating risk and reducing cost.
Moving into 2009, we’ll be working on a number of new initiatives. As you know, we’ve set a goal to de-lever our balance sheet by $2 billion by year end and we tend to accomplish this in a number of different ways, some of which we can be more specific about than others right now.
In addition to the receipt of all payments from GIC, which will generate cash of $1.3 billion, we intend to generate an additional $1.3 billion to $1.5 billion in proceeds, through contributions into funds, our newly formed joint ventures and outright sales of assets into the market.
First, let me address contributions. Currently we have US $1.9 billion of third party equity capacity in our funds, which we plan to use in different ways. We will use the remaining capacity, equity capacity of about $150 million in our Japan fund to sell an asset to GIC this year. We will continue to contribute assets into our Mexico fund, which has third party equity capacity of $250 million and in North America and Europe we’ve made some changes to our open end funds investor agreements.
In North America, we’ve reached an agreement on a one-year extension on the remaining outside equity commitments of $260 million through Q1 of 2010 in return for the elimination of the must-put, must-take arrangement. Our partners’ have expressed the desire to preserve equity in order to pay down debt if need be and/or take advantage of opportunistic acquisitions should they arise. The extension also allows for a postponement of any redemption request until March of 2010.
As for our European open-end fund, which has third party equity capacity of approximately EUR 850 million or US $1.1 billion will continue to contribute properties throughout 2009. However, we’ve agreed to evaluation adjustment to the independent revalued cap rate on 2009 contributions. This was due to the belief that appraisals were lagging through market conditions.
The incremental margin ratchet is down from 75 basis points in Q1 to 25 basis points in Q4 and the agreement provides for a catch-up adjustment at year-end 2010, should actual values at that time through higher than our contributed values.
In all cases, we’ve worked closely with our fund partners to achieve outcomes that meet their objectives and still provide us with adequate liquidity to monetize assets this year. However, given the current debt markets, we are planning to make contributions in 2009 on an all equity basis.
As such, the value of our development pipeline exceeds the equity available to take all future contributions. Therefore, our strategy is the whole much of the remaining development assets on our balance sheet as income producing assets, no different than our income producing assets that we held for year. It’s out of this total pool of assets that we intend to satisfy our additional liquidity initiatives in addition to contributions.
We’re in discussion with third parties on a number of fronts; from potential joint ventures to outright sales. Our goal is to run a parallel course on several options, only some of which we expect to happen. As many of you heard, we’ve been marketing various portfolios of assets in the U.S. and have received a significant amount of interest on various subsets of those assets. We’ll have more on this as transactions evolve further.
With respect to our efforts to de-risk our balance sheet, we’re making significant progress as well; between the Asia’s sales, Q4 contributions, reversal of our previously reported new development starts and a focused on our core business. We’ve significantly reduced our development pipeline from roughly $8 billion at September 30 to $5.1 billion at year-end.
Finally, let me briefly touch on market conditions. Yesterday, we put out our earnings guidance for the year, with our best guess of operating metrics; quite frankly this year is top to predict. Demand has slowed in all of our global markets, companies just aren’t moving much and we expect if some will contract. On the positive side, renewals will likely the above average; reducing downtime and turnover costs and new supply will be virtually shutdown.
On the negative side, we expect occupancies will fall, perspective rents will be soft and lease terms will be shorter. How much, will depend on how long and deep this economic downturn is. Frankly, I feel good about the overall credit quality and diversification of our customers. This should help mitigate our risk; however, make no mistake about it, we’re brazing for it to be a tougher year on the operating front.
Now, let me turn it over to Bill.
Thanks Wal. I want to focus my comments this morning on five areas: (1) Our 2008 result for the principle emphasis on the non-cash impairment taken in Q4; (2) The formatting and informational changes in our subliminal; (3) Our guidance for 2009; (4) Our balance sheet and liquidity position and (5) Our decision to pay our Q1 dividend in cash.
2008 FFO, excluding significant non-cash adjustments with $3.68 per share, near the top-end of the range of $3.60 to $3.70 we provided on our Q3 call and in subsequent investor meetings. This target was met principally due to our fund contribution activity in Q4, which generated nearly $1.3 billion of growth proceeds and approximately $1 billion of liquidity after our co-investment in the fund.
However, also in Q4, we incurred net non-cash impairment charges of $811 million, reflective of the very difficult economic environment as well as the sale of our China operations to GIC. The specifics of these are as follows: approximately $320 million associated with the write-down of various asset positions and goodwill in Europe, virtually all of which was associated with our Parkridge acquisition.
$198 million in our China operations, as a result of these impending since closed sales of these operations to GIC. Nearly $275 million of direct owned real estate of which $197 million was associated with our land bank, principally in the U.K. and $78 million was related to development properties and pursue costs. $108 million associated with an impairment recorded by our PEPR European fund, upon the disposition of its investment in PEP II.
These charges will partially offset by a gain of approximately $91 million associated with our successful December tender for the 2010 bond, wherein we retired $310 million of debt at a total cost of $219 million.
Turning to the changes we have made in our supplemental reporting, obviously we have made major modifications. To quote and old friend of mine, following his involvement in the rollout of new coke “everyone loves change unless it impacts them.” I realize these changes affect all of you and so I apologize for that, but candidly I believe that revised supplemental enhances our overall disclosures and over time will simply the presentation and understanding of our company.
Clearly, the biggest change in our reporting format is the elimination of our formal CDFS business segment. As we have stated since our investor meeting on November 13, our operating philosophy is changing. Our intent is to own and operate a geographically diversified portfolio of income producing assets on our balance sheet and grow our investment management business over time through acquisition activity as well as potentially undertaking future development activity inside the fund.
As a result, we have classified our existing development assets as a part of our overall portfolio of long term hold assets. Make no mistake; we intend to create additional near term liquidity from both development assets and our formal long term hold assets, but we are agnostic as to whether that liquidity comes from contributions into the fund or third party asset sale.
Upon the ultimate completion and lease-up of our development portfolio, though the assets that are not sold or contributed in the funds will become part of our long term hold asset; however, in order to retain transparency, we have broken out the development assets separately and will do so throughout 2009 and into 2010 if need be, to show just how we are doing relative to completions and lease-up.
Disclosures on metrics such as square footage, investment amount, leasing percentages, same-store analysis and others remain and we believe it’s been enhanced. Additionally, particularly in light of the current environment, we have expanded our disclosures relative to both balance sheet and fund related debt. We are very open to comments, questions and criticism of the revised format. It is different, but we believe better.
Next, let me cover our 2009 guidance. We are guiding to an FFO range of between $1.85 and $2.05 per share. The major drivers associated with this guidance, are average occupancy of 90% to 91%, down 150 to 200 basis points in the core industrial properties. Year end 2009 we think is a direct owned development portfolio 60% to 70%.
The remaining spend of $885 million is in the development pipeline, of which approximately $800 million is expected to be incurred in 2009. Targeted property contributions and dispositions of $1.3 billion to $1.5 billion, FFO gains of $220 million, principally from our disposition of the Japan fund interest and our disposition of one additional contingent plans to those funds and lastly, $320 million to $340 million of FFO from these and our share returns from the investment management business.
There are five important points to take into consideration relative to this guidance and our ongoing FFO run rate. First, we do not expect to generate anywhere near the amounts of development gains that we had on the past. Our development for contribution business model has changed and is unlikely to return anytime soon.
Second, while $140 million or $0.52 per share FFO gains from the Japan fund sale is not a reoccurring events, we believe the other $80 million of FFO gains can be achieved on an annual basis. Therefore and I am sure, many of you have already done the math; taking our 2009 FFO range and backing out the FFO gain from the Japan fund sale, results from the core FFO run rate of approximately $1.35 to $1.55 per share.
Third, embedded in the cost for 2009, is approximately $73 million of non-cash interest expense, associated with the implementation of APB 14 related to the interest expense, on our convertible volumes. Of that amount, we expect to capitalize approximately $11 million in 2009 and the remaining $62 million will be a drag on earnings, thereby reducing FFO by $0.23 per share, relative to 2008 U.S. GAAP accounting.
Fourth, relative to future growth potential, our challenge and our opportunity is that at 12/31/08, we have approximately $5.5 billion of non income producing assets on our balance sheet, comprised to $2.5 billion of land and 60% of un-lease space in our $5 billion development pipeline.
Clearly from an operating prospective, our focus will be intense on leasing our pipeline, monetizing our land bank and completing the right sizing of the company, all of which overtime in a pondful implementation should add and additional $1.50 to $1.75 per share to our annual FFO.
Finally, while we believe the ability to generate FFO and earnings is incredibly important. It is not our primary focus in 2009. In this environment, right sizing the company, generating liquidity, attacking debt maturities and simplifying the enterprise from both an operating and a transparency perspective, will be at the top of our new term agenda. Accomplishing what we want to accomplish may results in some substantial one time costs, none of which are embedded in our current guidance. If incurred we will update our guidance for 2009 accordingly.
Let me turn to our balance sheet and liquidity as of 2008 year end. At 12/31/08 we were in compliance with all our debt covenants and intend to keep it that way. We had access to necessary $1.25 billion of liquidity between cash on hand and availability under our global line of credit. We will increase this liquidity by $1.3 billion as a result of the sale of China and the Japan fund. Additionally, we are targeting asset sales and/or contribution of $1.3 billion to $1.5 billion in 2009.
The total liquidity generation of nearly $2.7 billion will likely be offset by combined development completion expenditures and co-investments of $900 million to $1 billion this year, putting us substantial on track, to reduce our overall balance sheet debt by our targeted $2 billion by year end.
Relative to our balance sheet debt at 12/31/08 we had $11 billion outstanding, of which $339 million matures in 2009. We expect to pay this off through a combination of cash on hand, secured debt financing or availability under our bank facility.
Relative to our fund related debt, excluding the Japan fund debt, we have $1.4 billion maturing this year; 99% of which falls into one-to-four bucket. Bucket number one is $491 million in PEPR, for which it has sufficient capacity to refinance this debt through a combination of cash on hand, asset sale in the existing PEPR bank facility. Additionally we are currently in discussions with various German banks, relative to rising incremental capital.
Bucket number two, is $314 million in the California fund, wherein we have term sheets from existing lenders to extend 100% of the 2009 maturity, for between one and five years. Additionally, we have rate locked on a new $100 million plus tenure financing, to payoff a portion of these maturity.
Bucket number three is $454 million in NAV II, of which the city bridge loan represents 90%. We have had good discussion with Citi, relative to both the equity interests and bridge loan, but there is still wood to chop on this one; finally $167 million inside NAV III, the Lehman Statutory loan.
We believe we have reached agreement among the parties to pay down a portion of this loan and extend the maturity for the three year period; however I will not count this one as done until all the documentation is execute. We are also clearly focused on 2010 maturities, both on our balance sheet and inside the funds, all of which will move up on the radar screen as we get into Q2 this year.
Finally let me address the dividend. Our board declared a $0.25 per share dividend for Q1, 2009, which we will pay in cash, weather to pay in cash or pay in a combination of cash and stock is clearly one of the hottest topics in REIT land today. There is no right or wrong answer here. However we have generated good liquidity in the last few months and believe our investors came in with an expectation of a cash dividend.
Our clear desire is to pay our regular dividends in cash; however given the current turmoil in the credit markets and the overall economy, we will review our position on this issue on a quarterly basis in 2009.
With that let me turn it back to Walt to wrap up.
Operator I think we’re ready to take questions please.
Thank you. (Operator Instructions) Our first question today will come from Michael Bilerman with Citi
Michael Bilerman – Citi
Good morning. Bill was very helpful to through the 2009 debt I know. From 2010 you said it’s going to come up on the radar screen, but maybe you can just provider a little bit comfort. Obviously 2010 with the global line and within the funds you’re totaling almost $7 billion of stuff to deal with and obviously a so much bigger amount then what’s happening in 2009. Just share a little bit about how you’re thinking about those plans and what capacity maybe there to refinance.
Certainly Michael, let me talk about both. On the global line of credit, as we talked about in the past, we had a bank meeting in December at which point we said down with all of our banks and talked about our desires and goals. We didn’t ask the banks for anything at that point, but we’ll certainly get back to them in early to mid Q1 to discuss a review and an extension of the global line of credit. That is very high on our rider screen.
We have been in conversions with the lead banks on that discussing terms and conditions etc, etc and we intend to attack that vigorously in the coming weeks and hopefully get a resolution to an extension on that facility and well past 2010, somewhere in Q2. So that is high on our radar screen today and we are active in those discussion.
On the fund side, we have probably seven to eight different packages out to various long term lenders at this point. More than half of those relate to 2010 maturities, both in Europe and the U.S. and so we are active in those, but at this point in time given all the things that we’ve been working on and driving towards and we just closed China, Japan and so now we can turn our attention at least in the finance area, focus them heavily on the 2009 and 2010 maturities and so we are very focused on all of those.
Again our primarily goal early in the year, first and foremost was to fix the 2009 and we think we’ve gone a long way in that regard and we’ve got a variety of decisions going on for 2010.
And Michael this Walt, let me just add to that too. I mean we have to be really careful when we’re talking about refinancing $7 billion. $4.4 billion of that is the line of credit. We don’t have anything near outstanding on that right now. I mean we have $3.2 billion, but that’s exclusive of $1.3 billion China sale; that’s exclusive of $1.2 billion to $1.5 billion of pay down, much of which will come from contributions to our funds and we we’ll talk about leasing and the like I’m sure on the call.
So we are not talking about refinancing $4.4 billion. I think at the end of the day, our hope and frankly the things that we’ve already disclosed to the market will take that number down substantially and so we wouldn’t be refinancing $4.4 billion, we’ll probably be refinancing in much lower number if you will.
And that’s part and parcel of the extension and review of that facility.
Yes, I don’t think anybody believes today that we need $4.4 billion out on our line of credits to run the company, so.
Our next question will come from Mark Biffert with Oppenheimer.
Mark Biffert – Oppenheimer
Good morning. I was wondering maybe Walter if you could talk about the leasing environment looking at what your tenants are saying, as well as when you look at your CDFS pipeline or the assets that you plan to contribute in ’09, how that leasing is going and how you decide for between which assets that you plan on keeping on balance sheet versus contribution?
Right. I’m going to give a general comment and then I’m going to turn it over to Ted to talk about the development pipeline which I think is probably the most pressing question, piece of the question I should say.
First of all, it’s fairly interesting Mark. If you just took 12/31 as the snapshot and we were doing this normally 30 days afterward; I’d say boy, surprising that what we see in the overall market is not that bad, but frankly you’d be crazy to put your head in the sand and not look out to what (a) what we’re beginning to see a little bit in January and (b) what we think we’re going to see based on reading the papers.
I mean we believe that occupancies will decline this year and we believe that rents are likely decline a little bit, because again it would be crazy not to say that’s going to happen, but having said that we are still seeing activity in our development pipeline and let me just make a general comment about it and I’ll turn it over to Ted.
About half of our development pipeline in Europe is in central Europe and we are seeing, believe it or not, still really good activity there. We still have a good amount of our development pipeline in Japan and we are still seeing good activity there. So while we are seeing softness in the market and we expect to see softness in the market, the development pipeline is still leasing and so I’m going to kind of turn it over to Ted and he’ll talk a little bit more about that.
Mark, in terms of where we intent to contribute assets and where we intent to hold, we mentioned we do intent to do one more contribution in Japan and the balance of the contributions will likely be in Europe where we still have substantial fund capacity and in Mexico.
In North America we don’t anticipate fund contributions this year and interestingly not in Europe, in our current pipeline, we’ve got over $900 million worth of leased space, which matches up well with what we intent to contribute in 2009. So, there’s not a lot of leasing necessary to achieve our goals in Europe for contributions in 2009.
Of our total leasing we got about 36 million square feet in our development pipeline to get leased; about a third of that is in Japan; about half of that is in Europe and the remainder is in North America.
In both as Walter mentioned, in Eastern Europe demand is still being reasonably strong and we still have great activity in Japan. If you were to talk to our people and we do on a regular basis, we have good activity on at least a third of the space that we have available on the market right now and if you take a look at our leasing over 2008, and extrapolate that into our current pipeline, there’s a little over a years worth of inventory.
If you were to look at it a little bit more cynically and say “well, 2008 may not be reflective of the environment we’re going to see in 2009” and you took the fourth quarter of 2008 and extrapolated that, we’ve got about a year and a half to two years worth of inventory to lease out and I think we’re guiding people to somewhere between one and two years of lease-up of our current pipeline.
Our next question will come from Kei Vin Kim [Ph] with Macquarie.
Kei Vin Kim - Macquarie
Could you talk about your North American portfolio that you’re marketing right now? How far along are the marketing funds or actually the sales funds and has that gone to with the end game being, actually signing goodwill?
I’ll let Teddy answer that question and ago ahead then.
We started marketing that portfolio late in December 2008 and have received great activity. We have received over 80 offers at several different portfolios and we don’t intend to sell all of the assets that we have offers on, but the demand has been significant and interest almost high. Obviously certain markets, the pricing is all over the map. We expect to conclude a sale or some sales sometime in the end of the first quarter or early second quarter and no pricing is going to come up, so we expect to see pricing in the single digits and that’s where the competitive offers are right now.
I’d like just to add to that, we’ve seen a broad range of buyers and we’ve seen people come in at $25 million to $50 million and then we seen other people come in at $200 million plus and so they are all over the map and frankly as Ted said we’ve been encouraged and at this point in time we’ll report back when we have more information to report back on.
Our next question will come from Louis Taylor with Deutsche Bank.
Louis Taylor - Deutsche Bank
Thanks good morning guys. Bill, can you just go over the guidance again and it seems like there is roughly four pieces and so you’re guiding to $1.85 to $2.05 with the Japan gain and other gains in there as well, but offset by the APB 14.1 expense in there. Is that correct?
Louis Taylor - Deutsche Bank
Okay and then just as a follow-up; in terms of the $1.3 billion of sales that occurred or contribution to funds that occurred in Q4, how was that capital applied, did it repay debt, did it fund development? Because it didn’t look like the debt and cash balances had changed materially at 12/31 versus say 09/30.
Well on the grand scheme of things if you sort of work through some of the map on the funds put into the development pipeline, first of all of the 1.3 or 1.275, there was about $285 million used for various co-investment activities and so left about $1 billion and that was used for various purposes in terms of attacking the 2010 bonds, as well as expenditures on the pipeline and our expenditures on the pipeline have comedown now to a total of over $885 million left. So in the large part, in lieu there is a lot of little ins and outs here and there, but that takes off the vast majority of it.
Yes Louis, when we met in November, recall that we had a cost to complete line item of around $1.7 billion I believe and that cost to complete is going from $1.7 billion to $885 million. So effectively the fourth quarter contribution’s paid for that, plus the other things.
Next we’ll hear from Jay Habermann with Goldman Sachs.
Jay Habermann - Goldman Sachs
Hey, good morning. Here it’s slowing as well. Guys did you walk through the development pipeline? You got the $5 billion currently in process; first, the $2 billion of existing partner equity and then of course you talked about keeping the additional $3 billion potentially on balance sheet or possibly looking at JVs etc, but I just want to walk through a few different scenarios. Number one, does this partially offset the $2 billion of de-leveraging that you’re talking about and can you talk number two, about pricing of assets in Europe; and three, just update us on where you might stand as you look into 2010?
Okay, well. Yes I guess let me start off by saying that in terms of the de-leveraging process, in essence Bill sort of took you through the map, but I’ll kind of take you through the map again.
If you looking at China, at $1.3 billion and you’re looking at an additional set of asset sales, lets call it $1.2 billion to $1.5 billion, okay and you’re talking about the completion of the development pipeline of call it $800 million this year; because keep in mind, we have $885 million to complete the $200 million and that’s not going to be spent unless you lease it and so we don’t expect to lease it all, so call it $800 million. I mean you substantially get there without any other activities.
Now, if you take the $1.3 billion to $1.5 billion, you say “gees okay, how of much of that is if you will sales off your balance sheet and how much of that is contributions?” Ted just said a minute ago that we have leased already in Europe, leased $900 million, that’s 93% plus already. So the point is that we feel like we’re pretty far along in terms of leasing and contributions, we just have to effectively finish up buildings, contribute them.
So some of that’s going to be in the form of contributions; some of it is going to be in the form of asset sales in the U.S., and some of it could be joint ventures in other areas of the world and the bottom line is if you take the two minus the development in completions you substantially get to where you need to get in terms of de-leveraging and we’re not talking about all the activities that we’ve got gone on, but that’s what we have in front of us right now.
Yes Jay, actually to be more specific, I did mention over $900 million leased in Europe and that is accurate. Of that $900 million, $620 million is greater than 93% leased, so I just wanted to clarify that one for you and then relative to pricing of assets in Europe, I think pricing of assets in Europe is similarly challenging to the pricing of assets in the United States. I mean there’s just not a whole lot of transactions to look to.
We talked about how we modify our arrangement with our fund partners in Europe to allow us to continuing to do contributions through an environment that is very challenging, relative to future prices, values. We have a system in place, we’re comfortable with that, we’re comfortable with how those values are going to be determine and we feel pretty good about our ability to contribute a substantial amount of assets.
In Europe in a way that’s going to stirred up, both ProLogis and its own partners and I think we made a lot of progress in the fourth quarter contribution and if you know our fourth quarter contributions overall, pre deferral margins were 14.5% and so even if you assume cap rates are moving by 50 to 100 basis points, you’re still in the money on contributions on an overall basis.
Let me just make one other point Jay, which I think is important if we get out. We do have $2 billion of partner equity that’s out there. Having said that and we are going to rely on some of that, of course as a sources of capital in ’09, but it’s a long term business and we are investment managers and our reputation is balanced; fund managers, managing the funds for investors is critically important to us.
So, while there is that much equity in place we’ve got to look at each fund as I was saying in the comments. Discuss the strategy with them and come to a balanced solution and in some cases we may use some of that partner equity if you will to pay down debt, if that’s the right solution within the funds, we’re going to do that and so we continue to look at that as a strategy as well.
Just Jay in the last part of your question again, on the covenants we look at those intently obviously these days and as we look hard at our game plan for 2009, 2010 and beyond, we believe that the covenants will not present a particular issue to us, but that’s all depended on what happens with the economy, what happens in a variety of different things, but again we think we have a pretty good coverage on that now.
Our next question will come from Steve Sakwa with Bank of America.
Steve Sakwa - Bank of America
Thanks good morning. I wanted to stay on the development scene for a minute. If you look at I guess page 3.2, you kind of layout about $3 billion of developments and I guess I’m trying to understand since you’re not moving to a strategy of keeping things on balance sheet, can you talk a little bit about the development yields. I guess that’s something that’s never really been focused on, it’s been more margins. Could you talk me about where the development yields are and Bill, what dollar amount do you expect to kind of bring on and keep on the balance sheet in kind of ‘09 and ‘10.
Well, let me talk about what’s going to stay on the balance sheet is anywhere from $3 billion to $4 billion of the $5 billion pipeline and I would expect to stay on the balance sheet and against part of that depends upon where we create the liquidity from some of the asset sales in the U.S. etc. and what are the joint ventures or funds may arise, but I’d assume a minimum of about $3 billion and a max of about $4 billion out of the $5 billion will ultimately stay on the balance sheet.
Steve the development yields as you know; I mean we are developing throughout the world. A significant amount of our development is in Japan where yields are substantial lower and so is debt and so I would say if you were to genetically take a look at our yields they are going to be between 6% and 8%, in different parts of the world, depending on where you’re at and how that market looks. I mean in some of the markets we certainly under wrote higher yields and we’re not going to hit him, but I think if you were to use a 6% to 8% range in aggregate that would be a fair reflection.
Steve Sakwa - Bank of America
6% meaning Japan correct?
Next we’ll hear from Jamie Feldman from UBS.
John Peterson – UBS
Hi, this is John Peterson. Thanks for taking my question. Just can you talk a little bit about your decision to contribute to all the development through all the equity and kind of what perspective you guys have gotten from investors? Then kind of going along with that, if you think about your business model maybe 3 years, 5 years from now and you’re ramping back up the development pipeline of the contribution business; can you talk about maybe what equity this year means in terms of the business model down the road and kind of what sort of things you did differently as you entered the business (Inaudible)
I’m sorry; the first part of that question again.
John Peterson – UBS
Yes, your decision to contribute that your development in all equities to your funds.
I mean all equity from. Look, at the end of the day if the credit markets lighting up and are available there maybe a scenario onto which we put a modest amount of leverage on the contribution and expand the availability of capital inside the funds.
In this environment from a conservative standpoint, our focused first and foremost in term of obtaining new permanent financing of which candidly there is more activity and more opportunity than some people may understand or realize, but our first focus is on de-levering, on replacing some of the 2010 maturities inside those funds and priming those out to a longer timeframe. So with that we’re intending to in essence de-lever the overall funds by focusing on all equity contribution in 2009.
The second part of the question is long term, 3 to 5 years out are we going to ramp up development pipeline again.
Yes, I would say John, first of all I really do believe that in good times, there are tremendous opportunities in terms of developing industrial, I think we all believe that, but I don’t think that the opportunities will be there just to do it on our balance sheet. I mean there’s more opportunities than there are funds available if you will to do it all on one balance sheet.
So we are looking very, very closely today at frankly doing a lot more development inside of our funds. It’s interesting; if you talk to our fund partners over the years, they would have loved to do development with us and frankly it was our choice not to do that and we’re not there today, but as markets recover and development does come back, clearly we are going to continued develop.
I mean sure we have got in my view, the best development platform in the industrial business throughout the world and that would be crazy not to, but its really a question of how you do it and I see us doing it less a 100% on balance sheet and more if you will through our fund structure, aligning our interest with our partners such that they are doing development and they are doing acquisitions with us in the future and we’re leveraging off of our investment management platform and our platform of people to provide a service to those investment management partners over time.
Next we will hear from David Fick with Stifel Nicolaus.
David Fick - Stifel Nicolaus
Good morning Dave.
David Fick - Stifel Nicolaus
Three part question, the retroactive adjustments and then the forward ratchets one the value adjustments that you have to make some of your fund contributions. I assume that those only go in one direction. Number two, should we assume any value in promotes from here. You’ve talked a lot about that over the year, but I assume that within the impairments there is an implicit loss of those promotes.
Then thirdly, sort of wrapped around all of that, I’m sensing an inconsistency in how you’re reporting and planning to report FFO. On the one hand you’re out of the development business; on the other hand you’re finishing up some development and you’ve consistently reported the gains in FFO, but going forward you’re sort of selecting which assets are being sold and excluding from FFO and others that are being included in FFO, it just seems to me that if the development model is broken, why won’t you just take that out of FFO entirely or is that just too cocooning for your multiple?
David this is Walt. I’m going to ask Ted to kind of hit the first one or Ted if you want to hit the promotes, I can hit that and then Bill maybe you can talk about the FFO.
Yes, David I’ll talk about the adjustments on the fund contributions. In meeting with our fund partners, there’s clearly a concern about appraisal lagging the market and to try to address that what we did is we came up with a mechanism where we adjusted the appraisal pricing down throughout 2009, that 75 basis points in Q1, 75 basis points in Q2 and it goes to 50 basis points and it goes to 25 basis point, in Europe specifically and with a look back effectively in December of 2010, so that in December 2010 the values are not reflected, reflective of the contribution values and they are higher; we get to pick-up, a catch-up if you want to call it.
So, we’ve kind of quantified our worse case scenario. That’s what you will see in terms of the numbers we’ve reported throughout 2009 and then there will be an upside to those numbers potentially depending on what appraised values come out at in 2010 and that was a way of kind of bridging a GAAP. That is this value adjustment is a short term downward adjustment, we have the ability to get hold and if it’s a permanent downward adjustment, our fund partner should treat it fairly.
Dave in terms of the promotes, there is a promote in each of the funds. They depend on the years of course, that we negotiated the deal that we set. For example the open ended funds there’s a promote every three years. I do believe that there’s promote coming up in the NAF, the North American open ended fund this year and I believe there’s one in PEP II next year.
There is a promote every year that we’re eligible for in PEPR etc, etc and I would say you’re right. I mean look, for the next year or two, I mean I don’t know, we haven’t calculated it, but I think values are going to be down and a lot of those promotes are going to be based on value and they are going to be some year we get it and there’s going to be some years that we don’t get it and we’re not planning any promotes this year in our guidance and order and don’t have any promotes in this sort of base numbers.
So as I said, some years didn’t get it, some years are probably not and we probably aren’t in a great position right now. So, we just got to see how that goes and then Bill maybe you could take the last part of your.
Yes, I’ll just add to that a little bit Walt and we’re not counting on it, we’re not guiding to it or anything else, but I mean looking at Q4 ’08 and into 2009, our fund partners are going to be getting these properties at a higher current return lower value, which candidly under the promote structures that are in place may offer an opportunity if markets settle back down to generate the promotes and so those opportunities may still be out there and enhanced quite frankly because of the current contribution values, but we are not guiding to, we are not counting on it, we are putting those to the side and we’ll identify those opportunities as they arise.
On the FFO front, the gain associated with Japan is recognition of previously deferred gains, which we’ve always recognized as FFO. The other contribution activity in 2009 again, when we contribute properties out of our development portfolio, we will recognize FFO to the extent that the contribution value is above original and so that activity will continue in the future. You will see us create in opinion, larger development management fees etc, etc, all of which are always in FFO.
If you look at our reconciliation for 2009 from FFO, from net earnings to FFO, you will see that we have gains in there, targeted for this year, basically off of our sales of assets. Interestingly and we anticipate generating a significant amount of gains out of our sales of assets off our balance sheet this year, those do not go into FFO and so our long term hold assets do not our near-term or our development properties will and that’s the way it’s always been treat.
Our next question will come from Chris Haley from Wachovia.
Chris Haley – Wachovia
Yes hi, good morning.
Chris Haley – Wachovia
Hi Walt. If I may, I just recognized your limiting the questions; maybe just to throw out a few here for you and see what you can do. First, the ‘09 guidance does it reflect the pending North American asset sale. Secondly, on the fund appraisal adjustments Ted, recognizing that you made these basis point adjustments on a sequential basis, should we take that off of a current cap rate number and that’s the new cap rate that will used in terms of an inflation factor, 75 basis points in each quarter for the first and second, then another 50, then 25 and then it’s static in 2010.
The last question on the leverage ratios, when you look at debt-to total assets, currently in the mid to high 50’s, I’d be appreciative of your view; where you think that ratio; where you’d like that ratio to be as we get into 2010, middle or later part of 2010 when the business models are little cleaner? Thank you.
Let me take the first and the third and then Ted you want to take the middle part. The asset sales of the balance are in our budget and our plan for 2009, but they do not generate FFO, so they are not part of the 2009. As I mentioned with David Fick’s question, we will generate or we expect to generate a gain off of those asset sales, but those hit net earnings not FFO.
In terms of the debt ratios, the mid to high 50s, today that’s higher than we would like. I think in the relatively near term and I don’t know Chris whether you want to call that 18 months to two years, we’d love to get that down into the 45% or below range. I think just in our game plan as it relates to 2009 and our de-leveraging plan, that’ll probably end up somewhere in the very low 50s, potentially the high-40s and that’s dictated off.
We do intend to reduce debt substantially in 2009, but it’s also going to be off of our slightly lower asset basis as we contribute some funds and sell some asset. So, I expect that will end up in the low 50s at the end of 2009 and our goal is to get it substantially low.
Chris, its Ted. On the fund appraisal process and the valuations, I think the way for you to look at it Chris is that our expectations; we’re going to be contributing at about cost in 2009. There are actually other assets to the evaluations that are not material, but do come into play and we do not have an obligation to contribute at below cost.
So, for some reason, when you make the cap rate adjustment, if it came in at a below cost, that would not trigger an obligation for us to contribute. It would allow us to move into another quarter, yet another quarter, yet another quarter, until the basis points just scratch it down, it will be new appraisals along the way. But I think from our budgeting standpoint, our expectation is we’re going to be contributing these assets of cost and I think that’s probably a good parameter of where we feel the market is today.
And operator we’re going to take one final question and then I’ll wrap up.
Our final question will come from Michael Mueller with JP Morgan.
Michael Mueller - JP Morgan
Great, hi. I guess following-up on Ted’s comments there, if we should assume your contributed costs, where does the $80 million of recurring gains come from the development that Bill, you said was in the numbers, that was one question. The original question was if we look at the ’09 and ’10 JV debt schedule that matures, can you give us an idea of the average maturing rates as a whole for each year and where you see the new rates?
Right, we hit the $80 million first, the $80 million we have this year.
Right. Well, I mean Ted’s probably Euro focused right now, but we do have margins within various asset pools that will be contributed and focused on Japan and even in Mexico and potentially in Europe itself, but additionally, there are going to be new funds and new joint venture interest created that will take some of those contributions in the future, but we also believe as I talked before and it’s interesting.
This world, things are on a downturn right now, but the fact is it’s not an oversupplied situation and we have an incredible amount of activity for discussions and requests, for building activity and so we’re going to generate FFO caliber development or development management activity and Walt can address that later.
In terms of the debt maturing in ’09 and ’10, I don’t have the sort of the rates. I have them here, I just haven’t anticipated the first part of that question, but anyway the rates are all over the board in terms of what’s rolling versus what’s coming on. Some of them were in the really high sevens and low eights today. The bottoms that mature later this year, other than tangibly or very attractive rates off them, you know floating rates bonds off the LIBOR on the balance sheet and so overall it’s at a whole variety of rates and I don’t have the specifics. I couldn’t quote to you sort of the weighted average on that, I apologize.
In terms of the refinancing rates, right now in terms of the long term debt that we’re looking at in the US, sort of the conversations are looking heavy. Sort of high six’s to mid seven is what we are seeing and call it a range of 675 to 775 depending on maturity. In Europe the spreads we’ve been quoting and they are sort of market flex built into those, but I think you can probably swap on some of the European activity that we’ve got going in the low to mid sixes and call it a range of 675 and in Japan it’s probably 2 to 250.
So overall, the spreads on that are wide and as I’ve said for a long time, you can’t get hung up from any statistical stand point on spreads, you’ve got to look at coupon and so that’s where we are focused. So it’s not completely evidenced in the grand scheme of things, not unattractive.
And Michael, I’ll just also respond. Bills right, I was Euro focused when we’re talking about the fund contributions. The fund contributions I was outlining we’re specific to Europe and I think if you step back and take a look at the size of our company and the assets that we have, even in a down market there’s going to be ways for us to make money and a few of those are; they are in the bunch of this year and there are some land sales that are already priced, that are solid sales or for you to make money; there’s some few developments.
There are potential for some pre sales of buildings, there are user sales of assets. We’ve actually got a lot of different ways to generate gains as long as the range in which Bill is talking about, I do think is a reoccurring opportunity for us and we’re active throughout the world in a lot of different areas and opportunities do come out.
Alright, let me make a couple of final points. It should be obvious to you that our number one priority is de-levering, de-risking our balance sheet through a number of initiatives. We will accomplish this goal this year, but what’s the price ahead?
Well, Bill talked about business in the $1.35 to $1.55 range of FFO, that’s a base business. That’s worth $5.5 billion of non-income producing assets. Near terms we’re got to lease up, we got to lease our development pipeline. If we do, that adds $0.75 to $0.90 to that base business per share.
In immediate to longer term, we got to develop and monetize $2.5 billion of land, which adds an addition $0.65 to $0.75 per share. We’ve got tremendous upside embedded already in our balance sheet paid for, and we don’t think that we’re going to need much capital to extract it. I’d like to thank all of you for your support during these tough times. As we said in November, don’t trust us, watch us. Thank you operator, we’re done with the call.
And that does conclude today’s teleconference. To access the replay of today’s call, you can call 1888-203-1112 or 719-457-0820 and use the passcode of 4370237. Once again to be able to listen to the replay of today’s conference, you can dial 1888-203-1112 or 719-457-0820 and use passcode 4370237.
Once again that does conclude today’s teleconference. We’d like to thank everyone for their participation and wish everyone a wonderful day.
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