Q1 2009 Earnings Call
April 30, 2009 8:30 AM ET
Melissa Marsden - Managing Director, IR and Corporate Communications
Walt Rakowich - CEO
Bill Sullivan - CFO
Ted Antenucci - CIO
Sloan Bohlen - Goldman Sachs
Kebin Kim - Macquarie
Ann Anderson - Regrowth and Income Monitor
Mike Mueller - JPMorgan
Dave Fick - Stifel Nicolaus
Cedrick LaChance - Green Street Advisors
Michael Hanes - Beach Point Capital
Scott O'Shea - Northstar Realty
ProLogis' first quarter results meeting and webcast. I am Melissa Marsden, Manager Director of Investor Relations and Corporate Communications for the company. Last evening, we issued our press release and our supplemental for the first quarter of 2009. But if you did not have a chance to print it, there are copies available out at the registration desk. This document, as well as the link to today's webcast presentation, are available on our website at www.prologis.com under Investor Relations. I apologize that we do not have hard copies of today's presentation for you. However, they will be available from the website at the conclusion of today's meeting.
And for those of you participating remotely, I would like to remind you that if you plan to participate in today's Q & A session, you will need to log into the webcast in order to send us your questions as the phone line is in listen-only mode. And then following prepared remarks, we will alternate between questions from the audience and those participating by webcast. And we know that this is I think 18 companies, reporting today. So we appreciate your attendance, and know that there may be some of you who have commitments related to other calls. We appreciate you being here.
This morning, we are first going to hear from Walt Rakowich, CEO, to comment on our focus and our progress related to current initiatives and the market environment. Then Bill Sullivan, CFO, will cover results, guidance, and refinancing activity. Additionally, we are joined today by Ted Antenucci, President and Chief Investment Officer, and Chuck Sullivan, Head of Global Operations.
Before we begin prepared remarks, I would 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 operating results may be affected by a variety of factors. For a list of those factors, please refer to the forward-looking statement notice in our 10-K. I would also like to add that our first quarter results press release and supplemental and presentation do contain financial measures such as FFO and EBITDA that are non-GAAP measures.
And as we have done in the past, to give a broader range of investors and analysts an opportunity to ask a question, we would ask you to please limit your questions to one at a time.
Walt, would you please begin?
Thank you, Melissa. Good morning, everyone. Folks, today, we are going to hit you with a lot of data in the next half hour to say 40 minutes. But through it all, I want you to keep in mind a few takeaways. First, we are making great progress on our financial goals. Second, our operating property performance metrics are down, but within our expectations. Third, our development pipeline is leasing up and represents in our view, a powerful tool for future earnings growth. Fourth, we have a great global business. With one of the only truly global franchises, where we have got operations throughout the world in the real estate industry. And fifth, we have high quality state of the art assets with some of the most talented people in the industry. Without question, we are succeeding in this challenging environment.
In our presentation today first, we are going to cover our focus and our progress, our operating fundamentals. And then I am going to ask Bill to come up and talk about the financial review, and then of course, I will summarize and recap. Now, on November 13th, Bill and I came here to New York, and basically outlined how we were going to move the Company forward in this environment. Our goals were to first and foremost preserve capital. Second, we were to simplify our overall business and communicate more effectively. Third, de-risk our operations, and fourth, delever our balance sheet. Since then, I think many of you know we have taken significant steps towards the achievement of those goals, and I am going to outline a few of those steps right now.
First, in terms of preserving capital, we eliminated virtually all of our development starts, as you know, and our land acquisitions. At that time, and into the first quarter, we shut down approximately $580 million of developments in progress. We also reduced our dividend, saving $290 million in cash. And we initiated the right-sizing of our G&A, initially saving $100 million in cash, which is roughly 25% of our total G&A savings. Now, we will continue to seek cost saving type efforts throughout the year and throughout the company. And, I will say that we will have more to report on that in the future.
We have also been working very, very hard to basically simplify the business and communicate more effectively to the marketplace. As many of you know, we eliminated our CDFS segment, frankly in this environment, merchant building is not a focus of ours. We also simplified our financial reporting, completely revamping our quarterly supplemental reports, with more focus on our balance sheet and more focus on our debt covenants. We increased communications with our shareholders, with the rating agencies, with bankers. I think many of you have actually commented to us that, favorably at least, that we are A, communicating better, and also the frequency of the press releases has been very, very helpful. We will continue these efforts moving forward.
And we have stepped up our internal employee communications. During tough times, you have got to over-communicate. At least, we found. And we have tried to do this through a series regular town hall meetings, webcast meetings, face-to-face coverage throughout the world, Internet e-mails which I try to send out every other week. And senior management calls. I think we have made actually great progress internally as well.
We have also taken some major steps to reduce the overall level of risk in our operations. Since 9/30 of last year, we reduced our development portfolio by $3.2 billion, roughly 40%. Probably more importantly, and as we are going to talk about it more in the future, we have reduced the unleased portion of that development portfolio. As we hold that development portfolio on our balance sheet, the key thing is reducing the at-risk piece of that. We have reduced the at-risk piece of that by $1.8 billion in, in essence, two quarters.
In Q4, we renegotiated certain equity agreements with our partners, which gave them more comfort on the market pricing that they were going to get. It gave us more funding certainty, and probably better long-term relationships in turbulent times. We terminated land purchase agreements where possible. We closed our operations in the GCC, India, and Brazil. Now is not the time for expansion. We reorganized our management team internally to enhance our operational controls and focus more on risk. And as a result of our sales of our balance sheet assets, we will be retaining more of our developments internally. And actually as a result of that, we will enhance our geographical diversity of our wholly-owned pool, as well as reduce its average age over time.
Of course, we have also been focused on deleveraging the balance sheet. From October 1, '08 through 3/31/09, we completed fund contributions of $1.4 billion. $1.1 billion net of our co-investment. We sold our China operations, as well as our Japan fund interest, for $1.3 billion. We put $1 billion of US properties on the market for sale. Bill will have more to talk about there. And we repurchased $358 million of our bonds at a 32.5 discount to par value.
Now, as a result of all of these activities, you can see on this chart, we have reduced our leverage right now, by $1.77 billion in six months, despite having to fund $900 million in developments and a little over $300 million that we had in contractual obligations. After March 31st, we only have about $570 million left to fund in the development pipeline and a very, very small amount of contractual acquisitions to go. Now, what have we done since then?
Since 3/31, I think we have accomplished a great deal more. On April 8th, we raised $1.1 billion in a follow-on-equity offering. Bill, will have more to talk about there. We repurchased debt, basically delevering the company by another $112 million. We have rate-locked on $344 million of new, secured on-balance sheet financing. And we closed our contributions to our European fund, as well as we sold ProLogis [Park Mosado], generating another $170 million there. And we closed on $50 million in third party asset sales. Bill, will talk more about the asset sales in a moment.
But I would say this. If you look at our sources and uses, and again, Bill will talk about the sources and uses and talk about all the things we have got going still this year. But I think you're going to find out that we are actually in a very, very strong financial position, not just today but moving into the end of the year. And I think a very good position to weather whatever future economic storm that we still have ahead of us.
Now, let me cover our operating fundamentals. And in doing so, I am going to touch on first, our operating portfolio, second, our development portfolio, third, the overall investor market, and then some risks and opportunities. As expected, leasing was down for the quarter. But in analyzing this, I think there are three key factors to consider. The first thing is, when we took our Japan properties out, which were 98-99% leased. The overall leasing went down by 30 basis points as a result of that. And that is because of the sale of those properties that took place.
The second thing is that there is every single year, if you go back and take a look at our results, you will see the occupancies tend to be the lowest in thefirst quarter. Why is that? Because there is seasonal demand, where companies sign month-to-month leases in the fourth quarter because of the Christmas season. We think roughly 25 to 30 basis points of the decline is typical seasonal demand that you can have in the fourth quarter that goes away in Q1.
Now the remainder of it, call it roughly 100 basis points, was from softening market conditions. And let's face it. The '08 financial crisis that we saw in the third and fourth quarter is now creeping its way into Main Street. We understood that. And we predicted that, in the beginning of the year. And so, our guidance was that average occupancies would go down roughly 150 to 200 basis points on average. Okay?
So if you sort of project that out, you say okay, well, you started the year at 94, where would you end up the year if your average occupancies were down 150 to 200 basis points. It would be roughly 90.5% to 91.5% rates. We still believe that this will be the case based on being down roughly 100 basis points strip out Japan, strip out the seasonal demand.
Now as for our other operating portfolio metrics, I think actually they have held up reasonably well in the face of the tough market. Average tenant retention, whether you look at the invest management business, or you look at the direct-owned portfolio, roughly 70%-71% on average between the two. Why so high? Because companies generally aren't moving, and this is what we expected to happen. TIs and commissions at $0.84 and $0.07, respectively very low. Extremely low, why is that? Companies aren't moving. They are not asking for TIs.
And as a result, in addition to that contractors, frankly, are very, very competitive today. And so our overall TI costs are lower. Leasing activity is down 13 million square feet, 9.3 million square feet, relative to last year. Some of that has to do with the overall market just simply being down. And that is what we expected to happen in this year.
Our same store portfolio, as a result, also pretty much mirrored the occupancy declines that we saw in Q1. If you take a look at average leasing down 1.84% in the operating pool, net operating income down 1.85%. What we did, just so you know, on the far right side of this page, we have historically talked about our same store results with our development lease OP in the numbers. And we thought it would be more effective to basically break that out because as we lease our pipeline up, it does mask whatever declines that you have going on in your non-development operating portfolios.
So the left side is without developments. The right side, as we lease our developments, interestingly enough, the same store numbers are going up because we have got a development portfolio to lease. So there you see positive 0.78%. Rental growth down at 4.19%, you have probably heard mentioned, there has been a lot of rags and things talking about how rents depending on the product type are down 10% to 15% market rents. I think that is true in certain markets. One thing I want to say, though, is bear in mind, that moving into 2008, a year ago, the rents in place were probably 5% to 10% below market. So while market rents have fallen, the in-place rents, we don't expect to fall 10% to 15%. Maybe more of a modest fall, which you could see in the first quarter, roughly 4%.
In terms of our development portfolio, I think we are making very, very good progress. From the peak point of June 30th of last year, where we hit an $8.4 billion pipeline. Our pipeline now is down to $4.8 billion, or a reduction of $3.6 billion from the high. Now, again, since we are going to hold the majority of these developments on our balance sheet moving forward, we will contribute some into our European fund and Mexico fund. But a lot of them will hold.
The key things we are going to talk about moving forward more is the leasing in the pipeline. And as you contribute properties into your funds, which are 95% or 98% leased, the leasing could look like it is going down. So what we are going to do is hold the portfolio static, the $5.1 billion portfolio was 41.6% leased at the end of the fourth quarter. That same portfolio at the end of the first quarter was 46.4% leased, i.e., we leased basically 500 basis points or a 500 basis point increase in the overall occupancy of that portfolio.
So, if you go to the next page. Looking forward, if we take our development pipeline at 12/30/08 of 60 million scare feet, and we assume that there would be some target vacancy in that portfolio. I would love to say that we will lease it to 100%, but I don't think that we will achieve that. Even in good times, I don't think we will achieve that. We target a 93% lease and deduct out 28 million square feet that is already leased in the portfolio. Our target square footage in terms of leasing, is basically 28.1 million square feet.
So the task at hand is to basically lease that 28 million square feet of space. Now if you take a look at our historical leasing, again first quarter always low. But going from 4 million to 6.6 million, 4.8 million, of course the pipeline was bigger back then, but nonetheless. The average leasing over five-quarter period of time is roughly 4.5 million square feet. And, you can look at it a lot of different ways.
At 4.5 million square feet, if they would lease you six quarters of the [leasing], if you just took the run rate of 3.2 million square feet, which is a tough quarter obviously. But still at that, we lease it over an eight- to nine-quarter period of time. At the last earnings call we had we said look, we think it would be substantially leased by the end of 2010 which would be seven quarters. Both those assumptions pretty much straddled that. I think right now, we are still in a reasonable position to say that we believe, based on first quarter leasing, that we should be substantially leased by the end of 2010, and that's how we are thinking about the business today.
As it relates to the overall industrial market, current condition is no surprise. Operating fundamentals mirror economic conditions. They are weak. Market occupancies have declined. Market absorption is negative. There is some shadow space, although not as much as we would think, to be candid with you, in some sublease space creeping into the markets. Uncertainty leading to lengthier negotiations. Customers continue to balance their relocation costs, which are downsizing, or moving. Most of them are just staying put, and limited new development.
Now, near-to-longer term, we are actually more optimistic. A couple of things. First, let's not forget, that there is significant obsolescence and owner shifts that are taking place abroad. And I will talk a little bit more about this in a slide, in a couple slides from now. But that continues to drive demand. And secondarily, demand in the US will improve we believe as GDP growth returns. Most experts are talking about a positive GDP in the third to fourth quarter.
We will see. Nobody knows in this room. I don't know. But I do know this. As GDP does come back, real GDP, so goes demand for industrial space. It is not in my slide program, but it is in an attachment when you go back and print these, we have tracked real GDP growth to growth in the overall growth and demand of space over a 25-year period of time, and I think you're going to find that there is an amazing correlation between the two.
Now let's have a look at a few charts, which I think help put things into perspective. On the negative side, we have seen absorption in the top 30 markets go from 158 million square feet to 23.9 million square feet last year. If you broke down last year into four quarters, you would see that the absorption went from positive to negative. No surprise there. And that the absorption in the first quarter in the bulk industrial space is roughly 18.8 million square feet.
The good news is that over a 25-year period of time, we have never had a full-year where there has been negative bulk industrial space absorption. Never. Now could this be the first year? Absolutely. All bets are off. You can't always look back 25 years and say that is going to continue. But why has that been? And the reason is because GDP has grown those years because the population has grown.
If you look at the projected population through 2020, 2025, we are going to go to 340, 350 million people in the US. We have only had four periods of time where we had negative consumption growth since 1950. Four periods okay. We are in one of those periods today. Will that resume? Hard to say, but eventually, I don't think so. And the proliferation of SKUs, we choose a lot more products today than we did way back then. And we will likely choose more in the future. All of those things complicate and grow the supply chain. And we believe that all of those things will continue again. And again in the Appendix, we put in some statistics on consumption, and we put some statistics in on population growth which we think in the US will drive our business long-term.
We have also seen declining occupancies. Just a tad above 90% today. Is it heading in the wrong direction? Absolutely. The flip side of that is, if you look at a 25-year chart, there has only been two times in 25 years where it has gone below 89%. Could we go below 89% this year? Of course. Are we expecting to? Don't know. But why is this? Why is it that the occupancies haven't gone below 90%, generally speaking. Because not only has there been demand growth, but the interesting thing about the industrial business is that you can cut off supply within a very, very short period of time. It only takes six months to build a building. Therefore, you're not out there that long when the market turns down, and that is exactly what we are seeing.
If you go to the next page, into '06 and '07 things pretty much in balance. Deliveries on the left, and absorption on the right. Did they get out of balance last year? Of course. Was it because we built more space than we needed to? Not really. It is because demand fell off the chart. And of course, it is still out of balance because deliveries are finishing up into this year with 24.8 million square feet vs. negative 18.8 in absorption.
The flip side of that, and this may be hard to see, I don't know. But these are the deliveries on the left side of warehouse space over the last 25 years. And you can see on the far right part of that chart, we actually think the deliveries will be less than 60 million square feet, which would make it one of the three smallest years in delivery.
Not withstanding the fact that the overall stock is double what it was way back. But deliveries are extremely low. So if you look to chart those deliveries on the right chart, relative to the total stock, there is only one other time in history last 25 years where the deliveries have been less than 1% of the stock. And so, we are really, really undersupplied.
And if you go to the next page, even more profound. Let's forget about deliveries, but let's look at just starts. Starts in the first quarter, we have rounded to two. It was actually 1.6 million square feet in the first quarter. If you annualize that, you're less than 10 million square feet. I am going to tell you something. Never in modern history have we ever seen, since the 1950s in the US, a point where starts were this low. Never, and so, why are we positive about the overall prospects for the business?
First, in the US and Canada, what drives the business US, Canada, and the UK? It is GDP growth, without question. But in addition to that, it is product obsolescence. We expect 1% to 2% product obsolescence per year, i.e., driving demand. There is 6 billion to 7 billion square feet of space in the market place. That creates demand of 60 million to 120 million square feet per year just to cover product obsolescence, we are at zero this year. Virtually zero, longer term this will catch up.
But the other interesting thing is in Western Europe and Japan, they are not even focused on GDP growth. What has driven our business in Japan? With zero GDP growth in seven years, how did we build a $7 billion business? We built it there because there is a huge shift from ownership to leasing. And there is huge product obsolescence there. That will continue in the future. We think this obsolescence abroad is two to three times what it is in the US, and third, GDP growth.
Have we taken a pause? Yes, we have taken a pause. Have these trends stopped? Absolutely not. And in Central Europe and Mexico, you have got to remember, that in those markets, new companies are expanding into the market. That is driving growth. And increased domestic consumption, with the wealth effect, that is driving growth. And then a lack of existing product, that is driving growth. Forget about growth in the economy. These are things that drove our business in the last 15 years. These are things that will continue to drive our business, moving forward.
As we look ahead, there are risks, and there are opportunities. Near-term, on the risk side, overall market conditions may deteriorate. Might they? Of course they might. This is a very tough market to predict, without question. But I will say this, I think we have predicted this year so far, what we see in the first quarter, pretty well. Lease-up in our development pipeline, could it be slower? Absolutely. Do we think it will be materially slower from being substantially leased at the end of 2010? Not at the moment.
Flip side of that is, we do have near-term opportunities. We will lease the $2.6 billion that we have in our pipeline that is not leased today. And when we do, you can put a number on it. 6%, 7%. Some return on it. You're going to generate anywhere from $150 million to $200 million depending on your numbers, of additional FFO. That is tremendous growth, in and of itself, for us. And that is paid for, and it is on our balance sheet.
We will also see new fund formations because the opportunities that I just described throughout the world are beyond our capital capability. Longer term, we see the sustainability that I just mentioned of the demand drivers that they will re-emerge. And we see that our global platform today that is still there will capture a more and more significant share of the market as we believe some of our competitors won't be around tomorrow.
And let's not forget the monetization of the $2.5 billion of land that we have on our balance sheet. The bad news is that we have $2.5 billion of land, but the good news is that it is paid for on our balance sheet. We are capitalizing no interest on this land today. And interestingly enough, we are beginning to see opportunities where we are working on transactions today. I believe that by the end of the year, there will be at least $100 billion to $200 billion of this land that will be put in place and actually returning a reasonable return on the investment by the end of the year. We will also look to monetize some of this land over time. But it is clearly an opportunity.
And so with that, I am going to turn it over to Bill to talk a little bit about our financial results.
Thanks, Walt. I am Bill Sullivan, Chief Financial Officer. Before I begin, I would just like to thank Ted for wearing a tie today. And we might give him a round of applause at the end.
I am going to cover three aspects of the company's financial position. A summary of our Q1 results, and our guidance for the year, with an emphasis on the impact of our recent equity raise. Number two, our financing activities since the end of Q1, as well as review the progress on both our balance sheet and fund debt maturities in 2009 and 2010. And three, an overview of our targeted asset contribution and sales activity for 2009.
2009 is going to be a confusing reporting year due to the change in our business model, compounded by our recent equity offering. First, let me try to provide some insights to our Q1 results. We reported $0.86 in FFO after adjusting for $0.04 of net non-cash gains, very much in line with our internal expectations. After taking out CDFS gains in various non-ongoing costs, our core FFO per share was $0.32, equal to Q1, 2008.
On a pro forma basis, taking our recent $1.1 billion equity offering into account from both an interest expense reduction standpoint, and a total share count of approximately 440 million shares, the core FFO per share, would be approximately $0.23 for the quarter or $0.92 on an annualized basis. Bear with me, and I will try to get you back to the core run rate, in another fashion, in a minute.
First, let me try to level-set fiscal year or full-year 2009 guidance. Our original guidance for 2009 was a range of $1.85 to $2.05 per share based on approximately 270 million shares outstanding, and a total range for FFO of $495 million to $550 million.. The underlying expectations, utilized to arrive at that range, have not changed in any material respect.
We need to now adjust this guidance for the equity offering, which will increase FFO by an estimated $26 million to $40 million through de-leveraging, increasing total FFO to a range of $521 million to $590 million for full-year 2009. The weighted average shares, for 2009, will be approximately $398 million resulting in a revised range of $1.31 to $1.48 per share, for the year.
Turning back to the pro forma core run rate, if we subtract the net gain of approximately $160 million from the Japan fund interest sale, from the revised 2009 FFO range, we get to pro forma FFO of $361 million to $430 million. Taking into account, the 440 million shares, this results in an annual pro forma FFO run rate of $0.82 to $0.98 per share, or $0.90 per share at the midpoint. This core FFO run rate does not reflect potential FFO from further lease-up of the development portfolio or other growth initiatives that we will pursue.
Let me turn to our balance sheet and liquidity position for a few minutes. We were very busy from last November through March 31st, as Walt described earlier. Our focus on liquidity and deleveraging did not stop there. Since April 1st, we raised $1.1 billion through our equity offering. We retired $280 million of debt at a discount, delevering by over $110 million; lined up $344 million in US Lifeco Financing, and just signed a term-sheet on an additional $45 million plus secured financing, in Japan.
Turning to a summary of sources and uses, this slide is way too busy to walk through this morning in detail. But let me try to simplify it a little, and cut to the chase. We generated well over $1 billion of liquidity in Q1, reducing our global line of credit, by $1.3 billion since year-end. We believe we will generate an additional $1.6 billion of liquidity during the remaining three quarters of 2009, providing us with sufficient liquidity to repay all but $226 million of the debt maturities through 2012. Two important points to bear in mind, this assumes no incremental asset sales, contributions, or secured debt financing beyond what I have talked about earlier. The $226 million would equal just 1.9% of our unencumbered asset pool.
Let me walk quickly through our near-term balance sheet and fund debt maturities. On balance sheet, we have $311 million maturing in 2009 and $2.2 billion maturing in 2010, inclusive of the $1.9 billion outstanding under our global line of credit. The $311 million maturing later this year is more than covered by the $344 million of secured financing we are in documentation on. Not even taking into account, the TM paid bond financing underway. For 2010, we have $250 maturing, exclusive of the global line of credit. This will be paid through either incremental secured debt financings, or existing balance sheet liquidity. Relative to the global line of credit, we have engaged with our lead banks to recast and extend this line with the intent to reduce the overall $4.4 billion commitment to approximately $2.5 billion, extend the maturity to 2012, and potentially 2013, and bring the covenants more in line with our bond covenants. We are hopeful to conclude this effort before the end of Q2.
Relative to the fund debt maturities, at March 31st, we had remaining maturities of $1.07 billion for 2009 and $3.1 billion for 2010. Looking at 2009, in the past 30 days, our funds have paid off or refinanced $700 million of this debt. Leaving the $411 million [NAPE 2] loan, as the only sizable maturity as of April 30th. We have been in discussions with Citi on this debt over the past 60 days or so, and have reached an agreement on a 5-year extension of this facility, subject yet to documentation.
In looking at 2010, the two big funds I want to focus on are PEP II and PEPR, which have $1.1 billion and $1.6 billion maturing, respectively. Taking PEP II first, this maturity is the warehouse line. PEP II has nearly $2.9 billion of unencumbered assets at March 31, 2009. We have executed term sheets on over $300 million of secured financing, and. another $800 million of financing packages out to various European banks; over $500 million of uncalled equity, above and beyond our contribution capital expectations for 2009. And have engaged the banks in discussions to extend the facility for two years, as a belt and suspenders approach. PEPR is a little more difficult, but we are highly focused on resolving PEPR's 2010 maturities this year.
We are in documentation on extending the [hypo] real estate facility for three years. We have engaged the lead banks to extend the bank line for a two-year period. And we intend to payoff the CMBS debt through a combination of retained cash flow, realization of an existing FX hedge, asset sales, and secured financing. The cash flow and FX hedge will generate over $200 million and is totally in our control. While the asset sales and secured financing are both in process and are targeted to generate over $600 million of proceeds, $300 million of which is either under contract, or under an executed term sheet. Finally, it is important to note that PEPR has over $2.8 billion of unencumbered assets. We have some wood to chop here, but are just as focused here as we have been on PLD's balance sheet.
Let me quickly run through our asset contributions and sales targets for 2009. We are guiding to total gross sales and contributions of $1.5 billion to $1.7 billion for the year. This breaks down as follows. $900 million to $950 million of assets to be contributed or sold through our third party funds, of which $725 million, plus or minus, is targeted for PEP II. Of that, we closed $131 million in the first quarter. We have $538 million of assets within our development pipeline that were greater than 93% plus lease at March 31st. And of that, we have contributed $42 million in April. We are targeting $75 million of contributions for the Mexico fund for 2009, of which at this point, 47% plus is greater than 93% leased. And we closed on a $128 million sale of [Giloges Park Masado 2] to GIC just about a week ago.
We are also targeting asset sales of between $650 million and $700 million for the year. We closed on $5 million of that in Q1. At March 31st, we had 80% plus of that either under contract or LOI. And of that, we have closed $50 million since the end of Q1. Relative to our expected contributions, we have more than sufficient unfunded equity in each of the PEP II and Mexico funds.
Finally, let me conclude by summarizing what we have accomplished from a deleveraging perspective. At 12/31/08, our total funded debt to total undepreciated asset ratio was 52.4%. On a pro forma basis today, this ratio is down to 43.3%. And given our continued 2009 liquidity activities, we are hopeful to reduce this to around 41% by year-end.
Thank you. Let me turn it back to Walt, to wrap up.
Thank you, Bill. In summary, we think we are making great progress. Great progress on the financial front. I hope you all agree that we have chopped a lot of wood in the last six months. We still have a little more to go, but we have made a lot of progress. The operating property performance again is down, but clearly, within our expectation. We are not surprised by anything we saw in the first quarter. Our development pipeline and our land bank for that matter. But our development pipeline is leasing up. Our land bank and our development pipeline without question, which represent a powerful tool for future earnings growth.
And I think we have got a great global business. Let's not forget what we have out there. We have got terrific assets. We have got high quality customers. And we have got the most talented people in the business. And that will continue. As Bill and I said in November, don't trust us. Just watch us. Hopefully, you all have watched us, and you're pleased with that progress.
With that, we can open this up for questions. Thank you.
This question submitted by Sloan Bohlen of Goldman Sachs.
Sloan Bohlen - Goldman Sachs
You mentioned in your release that you were re-evaluating how you approach asset sales following the equity raise. Can you give us a sense of what that means both for the $700 million of wholly-owned and the $585 million of stabilized development that is either being marketed or is available for contribution? Is it a matter of cap rate or margin? And how do competing assets for sale in the market affect your timing?
Let me take a quick shot. I walked through in one of my last slides the asset sales. Our expectations for the year have actually increased since the beginning of the year. I think we had originally guided at $1.3 billion to $1.5 billion growth. We have talked in the last 30 to 45 days about a slightly larger number. And, in fact, we are still targeting that number, which is $1.5 billion to $1.7 billion. However, we raised more in the equity offering than was originally planned.
And so, from our perspective, we have the opportunity to take a look at things as the year progresses and cut back on some of that, if, in fact, a deal or two, tries to get re-traded. Or valuations go against us from the contribution standpoint. However, we are still targeting at the midpoint about $1.6 billion. And I walked through the pieces of that a minute ago. And we are on track to make that happen.
I was wondering if you can talk about FFO trajectory. You put up this whole slide of core FFO of 82 to 98, and there was some talk about it increasing as you bring on the developments and other sort of initiatives. But I am wondering if you can talk a little bit about the potential downside from that. You have $11 billion of debt at 4.8%. Obviously the refinancing of that debt overtime put aside the deleveraging impact, but just the refinancing of the debt is going to be coming at a much higher rate.
And then, there is going to be further deleveraging. So talk a little bit about what that impact is going to have to core FFO? But also in the development pipeline, as you lease that up, I assume the cap interest is also going to come on to the balance sheet or on to the income statement. So that is going to depress you won't get the full benefit of it into earnings.
Well, I mean there is a lot of things that I mean, funny when we were putting this slide together, the danger of putting that slide together is that you can't extrapolate that and say, well, that's what it is going to be because there are a lot of moving pieces. I mean, as you said there are positives, and there are negatives. On the flip side, one thing you didn't mention is capitalized, or is G&A. Because actually if you look at G&A next year, the run rate will be lower than it is this year even without regard to a little bit of capitalization that is in the numbers this year.
And frankly, we believe that based on some of the things we have got going on, that actually there will be some development next year. It may not be with our own capital, but we have got meaningful progress in customers that want us to build them some buildings. So I think you will see either a capitalized portion, or you will see a fee portion that begins to float in that you don't see in the numbers this year.
So it is really dangerous to take a look at it and just look at the downside associated with it. And say, well, there is no capitalized interest and the like. I think to be balanced about it, there will be things moving on one side. And then there will be other things that perhaps, either you know about or you don't know about today that will go the other way. Or that we haven't articulated. And we will just have to see how that all shakes out in the next year and when we give guidance for 2010.
Please wait for the microphone.
Just a magnitude of the debt, I would assume is a big drag. Just because it is such a low rate, and eventually when you recap the line, I assume it is not going to be LIBOR plus 50. It is going to go up LIBOR plus 300 to 400. Refinancing all this debt is going to carry much higher interest rates than a weighted average of 4.8. And certainly, when you buy back the converts, it is going to be, you are not going to get convert pricing. So I am just trying to put a box around the refinancing and the deleveraging impact to FFO. And I can appreciate the development increases. But just trying to put everything together of where does core FFO go when we look out two or three years from an earnings growth perspective.
Well, let me touch on a couple of things. And again you know, as Walt said there is going to be a lot of moving pieces. So bear with us on that. But in the grand scheme of things, when we went from the $0.32 (inaudible) etcetera. Keep in mind that that was first quarter results which carried much of that $11 billion of debt through the first quarter. And in terms of the convert interest, included in those numbers, is in fact the increased effect of the convert interest due to APB 14. So it is not coming in at 2%. It is coming in at 6%. And so the weighted average interest costs went up.
And so a lot of that is already baked into that. The fact is that we are down to $9.3 billion of debt at the end of the first quarter. We think we will be down to, somewhere on the order of $7.5 billion or maybe slightly north of that, at the end of the year. And so the debt load is coming down substantially. We have talked about in the past, and I think we have proven out. We intend to delever. Our original target was $2 billion. And we are going to beat the pants off of that, relative to year-end 2009.
I think the other thing I would add to that, too. If you're just focused on the interest costs in the numbers that Bill is putting up. Basically we are assuming that the savings and interest would be anywhere from a 2% to 4% return, I think it is. i.e., you paid down your line of credit. I'm not sure in reality that that is where we will completely deploy all of our capital. I think if you look at it, we would hope that we are going to get, if you will, a higher return on the equity raised than a 2% to 4% number.
And so, I think that you really got to be careful extrapolating everything from just the slide that we put up. We tried to put it, so we could at least have this conversation. But there are, again, a lot of moving pieces, both pluses and minuses in the future. I do think one thing I will say is, I think the lease-up of the pipeline, which if you think that it is $150 million to $200 million of additional FFO is going to dwarf a lot of other moving pieces. Substantially dwarf it, from here.
Yes, hi. As the supply of credit has shifted over from like the CNBS market into the Lifecos, could you give us just a little bit of background about what you're finding from them? What the difference in the terms are? It really seems to be, quite frankly, three months ago people thought there was no credit available. And now there seems to be a source of it. So it would be very interesting to know what you're seeing in that?
Yes, let me just comment on that. Well, first of all, we never did any CMBS in the US. We did a couple of CMBS issuances in Europe through PEPR. But focused on the US Lifeco market, if I try to put things in perspective, if you went back two years ago, the sweet spot for a Lifeco deal, in terms of size, was probably $250 to $300 million per deal. And if you went back to 2008, remember in 2008, throughout our funds, etcetera, we placed over $3 billion of financings within the system. And so, we have a fair amount of experience with it. But the average size, the sweet spot for the deal went down to about $150 million to $200 million in 2008.
As we have come into 2009 what we are finding is, the sweet spot in terms of size for a deal in the US is somewhere around $100 million. And so the absolute magnitude of any one deal has come down. It actually plays pretty well for the industrial sector. Because we can package up 15 or so assets and give people geographic diversity and credit tenant diversity in a secured pool. And that is a relatively good thing. In terms of overall terms, on the three financings we have rate-locked on, one is $100 million deal at a five-year interest only, 6.5 coupon on it.
The $222 million deals are 10-year interest-only at 7.55%. The Japan financing is going to be well under 5%, and it is a three-year deal which is sort of typical for the TMK bond financing. And I just take it across the pond to Europe. Again, candidly the average size of the deals in Europe. Two years ago, people were looking to put on EUR 200 million and EUR 300 million deals. And the absolute sweet spot today is EUR 50 million to EUR 75 million.
Unfortunately, we have got to work a little harder, in terms of each of the deals. But what we are finding is, that there is credit available. I think that that will shut off at some point during the year. It always does. In 2008, the market went away in October, and shut off for the year. And so we are not wasting any time getting done what we want to get done in anticipation of maybe an earlier shut-off this year than in past years.
We will take a question from the web from [Kebin] Kim of Macquarie.
Kebin Kim - Macquarie
This quarter you separated out $10.6 million as investment management expenses. Does this come out of the G&A bucket or other line items? And what is your expected 2009 G&A run rate.
Well, what we have tried to do, and hopefully you will get better insight into our Q1 10-Q. As we talked about, we have eliminated the CDFS business segment. And we are re-segmenting the business in essence into the core operations and then the investment management business. And we will break out core operations on a geographic basis and the investment management business separately. And in that vein, what we hope to do, if not in the first quarter eventually, is fully allocate all the expenses in that segment analysis. And so, we have gone through the exercise of identifying the specific costs associated with the investment management business.
So if you look at the roughly $10 million assigned to the investment management business in the first quarter, about $5 million of that came from what otherwise would have been classified as real estate expenses. In essence, expenses associated with managing the properties. And then about $5 million came out of G&A expense on that line item which is the direct cost of the investment management people focused on the asset management and oversight of the portfolio.
Ann Anderson - Regrowth and Income Monitor
Hi, Ann Anderson with Regrowth and Income Monitor. My question has to do with what is actually in the distribution centers. Can you break it down, roughly, between retail channel versus manufacturers' inventory? And also give us a sense of how that defers between North America and Europe?
What is physically in the centers themselves? Essentially you're looking at a large portion of our customers are third party logistics companies. And they will have a myriad of product within their center. However, then you get into consumer goods food, apparel. All of that blends into retail. Very-very limited automotive and supply and building and furniture. Very limited in that regard. That is pretty much what makes it up.
There is wholesale in there. And particularly on the consumer goods and the food side it break downs between wholesale and retail.
Good morning. I was wondering, looking at the size of the development that you have left to lease up, I am wondering what kind of conversations you're having with your existing tenants in terms of further expansion on their part? And how much of that space you think they are going to take versus new business that you're going to have to go out and try to either steal or raise, given the economic environment where it is at right now.
We are clearly always trying to expand existing customers in facilities. In this environment, there are relatively few companies that are actually expanding, so that is not a huge area of opportunity for us. But because we have got customer relationships throughout the world, I think about half, maybe a little more than half of the leasing that we will do, we anticipate doing with customers that are already in ProLogis buildings elsewhere throughout the world, or that we have relationships with. I think we are probably going to end up being somewhere in the 50% to 70% repeat customers.
Are you giving any kind of discounted rent to try to attract them to take more or concessions to get that business?
Absolutely. I mean, the market is very competitive. We are very focused on collecting rent. That is the business we are in, collecting rent. And today you need to be more aggressive certainly than we were last year or even six months ago to keep our buildings full.
And actually I would just add to that. I would say the edict beginning late last year was, solve for occupancy, not rents, in general. And, I think that our people have done a remarkable job in doing that.
And the other thing that we have done is, it is interesting, because most of the customers are looking for this today, is going shorter term. It used to be that you didn't want to do less than a five-year deal in a new development building, maybe a four-year deal. But today if somebody wants to come in and come in at a reduced rent, perhaps it is a little bit less than market. But if you get them to come in for two years, the good news is that eventually you do believe that they are coming in at a pretty low rate. And you can play that game to a certain degree. You get them in the door. You get some cash flow in the short run, and you got some rent upside. Unfortunately what we don't like to do these days is cut a deal at a deep discount, on a long-term basis. I mean that probably doesn't work all that well. If we have to, we will. But it plays better to do a shorter term lease, if you have got a big discount.
Our next question comes from Mike Mueller of JPMorgan.
Mike Mueller - JPMorgan
I believe you said average occupancy for the year would be about 91.5%. Please correct me if that's wrong. Are you operating under the assumption at this point that 2010 occupancies will be flat, lower, or higher than '09? And also, in response to the questions, please speak louder into the microphone.
What we said was we thought that, Mike how are you, first of all? What we said was we thought that the average occupancies would be down 150 to 200 basis points. We started the year at 94.7%. The good news we started the year at very, very well leased numbers. And so if you're down 150 to 200 basis points on average, by definition if you straight-lined it down and you assumed that occupancies went down the entire year, you would be, call it 300 to 400 basis points down from a 94.7% number. So, you would actually end the year at roughly 90.5% to 91.5% lease.
Now again, one thing you got to be careful looking at the numbers, which I mentioned in the presentation was that 30 basis points of the decline was just taking Japan out of the numbers. And another 25 to 30 basis points was seasonal demand which we see always in the first quarter. So if you strip those two numbers out, basically occupancies were down probably a little over 100 basis points. And that is the way we kind of think about it. So if that's right, pretty much what we thought going into the year looks like it will pan out. Meaning that the year-end occupancies would be in the low 90s some place. 90.5%, 91.5%. Again, we are going to continue to look at it as time goes on, but that is kind of the way we see it today. Did that answer Mike's full question? What was the second half?
It was to speak more loudly.
Hopefully, I spoke more loudly, Mike.
With respect to the Lifeco financings, can you provide any color around loan-to-values? And what kind of underwriting valuations you are putting on those?
Yes. Basically, we are doing deals anywhere from probably, 48 to call it 58, loan-to-values on those. And the cap rates relative to valuations range from 8% to 9%.
Dave Fick - Stifel Nicolaus
Good morning, Dave Fick, Stifel Nicolaus. You basically just acknowledged that you're buying occupancy, can you talk about how that is affecting the yields on your development? And are you seeing tenants transfer out of existing properties into the newly developed properties?
I don't know that I described it as buying occupancy. We are being competitive. I mean, it is a competitive environment. I think in a lot of industries. And we are competing. It is absolutely affecting our development yields. Our development yields aren't going to be as high as we had underwritten or anticipated. The contributions that we intend to make this year that we are projecting to make were still at a break-even-type level. We are certainly losing our profit, and there is absolutely going to be some transactions where we will do worse than that. But what we think we will be contributing this year, we should be at about break-even. In terms of tenants going from existing buildings to new development buildings, we are not seeing that yet. I don't know that we will necessarily see that.
We certainly aren't targeting to pull tenants or customers out of one building and putting them into another. We are trying to accommodate whatever makes sense for the customer. There are situations where customers want to get out of leases in one location in the world and move into a building in somewhere else in the world. And it is just their businesses are changing, and we are trying to work with them and accommodating those changes. And I think we have got great customer relationships, and we are able to capitalize on those opportunities when they come up.
And I would say, Dave to add to that, I mean, look, if we were planning for a 8% to 9% development yield in the US before, pro forma? I think you could assume that that deal is going to be anywhere from 5% to 15% below what we originally thought. Candidly, so, an 8% to 9% it would depend on the city and all those things of course. And I think Europe was probably the same thing. So to think about the lease-up of the development at a 7% number, or 7.5% number is something like that. Which would be, call it, as I said, 5% to 15% below our original performance probably not too outlandish in this market.
Hang on, David.
We got the microphone coming down.
Dave Fick - Stifel Nicolaus
I didn't mean to mischaracterize the words buying occupancy. But you did specifically say we are trading rate for occupancy.
Dave Fick - Stifel Nicolaus
I think that is fair.
Would you rather we not do that?
Dave Fick - Stifel Nicolaus
Well, I think it is a fair characterization. The issue is, what could this mean in terms of additional impairments? Given that I think you just said, a 7% yield, against sale cap rates that are substantially higher than that.
I don't think the sale cap rates are substantially higher than that for new product. Not at all, as a matter of fact. If you look at first quarter contributions into the European fund, they were completely break-even. And, by the way, that is with adding 75 basis points on to the appraised cap rates. And appraisals are beginning to catch up to reality. And so, no, at this point, the only data point we have is first quarter. We didn't lose any money on the contributions. We didn't make any money either.
Just to add to that, I mean we have a partial datapoint in Q2 because we have had a Q2 contribution. But I mean, candidly, our appraisals came in for both Q1 and Q2 contributions in Europe at just above 7.5%. And we added the 75 bps that we agreed to with the fund partners to that. And so contributed it at around 8.25 or plus or minus which in essence was at our development yield on those properties. And so, we have had those contributions. We basically broke even on those contributions. But we generated liquidity and have utilized that.
You talked about your capital sources for the year, and how that addresses your needs through 2012, and how that would get you to a debt to gross asset valve in the low 40s pro forma by the end of the year. Is that where you see the business running on a long-term basis? Or should we expect additional deleveraging efforts next year? Or do you feel like by the end of the year you're at a point where you could start to spend some additional capital to try to realize some return on the non-income-producing assets that you have now got on your balance sheet?
Yes, we have conversations internally about this all the time. And one of the long-term questions that you have to ask is, where do you want to be from a debt rating standpoint? We clearly would like to be higher than we are today. But you know that BBB plus range would be a target. As the credit markets evolve, we will have to see what it takes to get there. And whether it makes sense to try to move that up into the A range?
And what it takes to get there. In the grand scheme of things, 40% or thereabouts, in terms of just that metric is probably what we are targeting on the long-term. If there are opportunities that present themselves, we will try to take advantage of those. But low 40s, high 30s, is probably a good target over the long-term.Well, the other thing I would say is, and I know that a lot of the ratios are calculated off of book. But in reality, let's face it. The whole market is deleveraged because the perceived values are less today than they were a year ago.
Now you could argue whether or not the perceived value is less than our book value, and every breed is a little bit different. But I would say that, if values over the course of the next 12 months continue to go down in a relatively precipitous fashion, that would change the way that we look at it without question. Not withstanding, forget about the fact that the book value didn't change, the real values did. And we would view ourselves as probably too highly leveraged at that point again. And we would have to take another look at it. Do I believe that is going to happen? I actually don't. What we see a lot of in the markets today, is stabilization.
When we went out with our package, we were shocked. We went out with our $1 billion dollars package in US. We had 87 offers. Now they were all over the map. But there are people out there that want to buy this stuff. And actually, you know at the end of the day, quite frankly, in what we think is a distressed time, the cap rates came in at single digit-type numbers. So the worst of everybody's fears, I think, were just that. They were fears. And in reality, I think that one of two things is going to probably happen in the course of the next couple of years. Either cap rates stabilize and maybe even come down a little bit, or we will get back to a point where we see rental growth, because you can't if you look at the whole portfolio at an 8 or 9 cap, it is probably 30% below replacement cost.
Nobody is going to build a thing out in the market for anybody if there is growth until we see rental growth or we see something change in the market place. If that all does pan out over the course of the next couple of years, strangely enough, you might look at 42%, or somebody might, and say, boy, these guys look underleveraged. Will that change the way we look at it? Probably not. But it depends on the market conditions that occur, looking out. And we are just going to have to move with the market. Right now, we feel a lot better about the number at 42 than we did where the number was six to nine months ago.
And you know I would just add to that obviously, a fair amount of empirical evidence that we have is in the US relative to our own portfolio sales. But to put things in perspective, we have had two sets of appraisals in Europe so far. And you may have seen PEPR released its data yesterday. We have an asset sale program for PEPR as well. We have about EUR 115 million portfolio in the contract at a relatively attractive cap rate. In the grand scheme of things, we are seeing more and more empirical evidence. On the same side in Japan, every indication we have gotten from both sales as well as appraisals is in that 5.7% cap range. And so, the dramatic increase hasn't flowed through. That we have expected.
Yes, and I would say one other thing. It is interesting our asset sales that we are doing in the US today. At the end of the day, we will generate probably somewhere in the neighborhood of a 10% to 15% premium to our book value, gross book value. And so, some of what you see on the books is, if you will, undervalued even at today's prices.
I mean just given that it is difficult to figure out where that value is, are you thinking about it from a debt yield perspective, or something like that, from a long-term capital ratio?
It was really tough to hear you.
Sorry. Just given that it is difficult to figure out where the values are? Are you thinking about your capital ratios more from a debt yield perspective? And where that would get you by year-end?
Well, we have to. Your covenants require that there be certain amount of coverage. So, you have got to be cognizant of that as well. You got to look at all these things in the overall determination of where your levels ought to be on a long-term basis.
I have an additional question from the Web. Your pro forma core 2009 FFO of $0.82 to $0.98, obviously excludes the Japan gain. Does it include other gains? Your prior business drivers guidance for 2009 noted $220 million of gains, $180 of which was Japan, and excluded from the $0.82 to $0.98 range. Is it correct to assume that your pro forma core still anticipates about $40 million of annualized gains in it?
We will probably generate somewhere on the order of that. In increment. As we talked about, the sale of [Mosado 2], which took place in April, we are going to generate a gain off of that, but part of the empirical evidence on the cap rate environment in Japan. And so, and we will in the future, which we have said back at the end of the fourth quarter call. And so, clearly there are those opportunities. But that number also includes the development management fees, etcetera. And so, that is, in our opinion, largely recurring revenue sources.
If we can just go back to leasing environment. Your rental growth number that you quote, the negative 4.2%. Just remind us if that's cash or GAAP? And if it is cash, are you adjusting for free rent and your CapEx and TI trends? The volume of leasing, and what that represents that quarter? Or is it trailing 12 months? I just couldn't remember?
Yes, Michael that is a GAAP number, not a cash number. I don't have the cash number. We can get that to you. I don't know that it is going to be materially different from that. But I am not sure I understood, could you repeat the second part of it? I am not sure I understood.
If it is GAAP, does that represent the leasing that was done in the quarter? Or is that a trailing 12 month number? The negative four number?
That is just leases that basically turned in the quarter.
So, whatever new leases you did, whether it was a renewal or whether it was a new customer that came into a vacant space. That is the rent in place from a GAAP perspective. So it is rent-leveled, divided by the old rent-leveled rent that was in place from either that same customer or the prior customer.
So it is not leasing that was done in the quarter. It was leasing that was taking place in the quarter.
It was leasing that was done in the quarter.
Right, so it may effect future periods.
It would affect future, that rental growth or lack thereof, will affect more future periods than it will that particular quarter.
Yes. And then just talk a little bit about the leases that you're signing. How much free rent if any are you having to give, and how does that change between the core portfolio versus what you're signing in the development portfolio? And just circling back to David's question of how does that really affect your development yield in terms of the type of leases that you're signing there versus the types of leases that you're doing in the core?
Can I just say one thing before Chuck answers that question? If there were rent concessions free rent, for example, that is baked into that 4.19% negative rental growth. It is just the rents that you did versus the rents that were in place, taking into account rent concessions.
Michael, how can I additionally answer that question for you? I am sorry. The concession levels vary from market to market. There is free rent in both the operating portfolio and the development portfolio. It really is a market-specific level of concessions. Ted, you want to allude to that or extrapolate?
In the development portfolio, there are extreme situations, right? There are some markets where there is no competing buildings, and we are actually hitting our pro forma. And then there are some where there is a tremendous amount of competition. We are competing with five or six buildings. All of them can accommodate it. It is the first customer that has come along in a while. You can see as much as six to 12 months of free rent. We have been in environments where we have been competing at that kind of level. But, I would say that is the extreme far end. Three months of free rent would not be uncommon.
And if I can have one quick follow-up related to the development yield. Is there a difference between the yields on the stuff that is being contributed, versus the stuff that is eventually going to be held on balance sheet. So I assume at this point, all the US stuff is being held. And the Europe, Mexico stuff will be contributed, and I think you talked about that is probably going to be sold at par.
And so there won't be any gains. And you will just get back your capital relative to your 20% stake. But I am just trying to think about now the stuff that's being held on balance sheet. How do those yields compare to what you were thinking about? How does that yield compare to where your cap interest is to really understand what that growth potential is as those assets come online and you lease them up.
It is not easy to characterize in one number. It really is all over the board. I would say across the board, the lease rates should be accretive to cap interest. Certainly in aggregate, we are not leasing buildings for less than what we were capitalizing interest at. So I think that it's fair to say that there is clearly upside there. Some of the buildings, frankly, have been available more than 12 months.
And we quit capping interest so that would be totally accretive. It is a mixed bag. We spent some time yesterday talking about that. We anticipated these questions, and I think we will work hard toward coming up with all of the inflows and outflows that will occur this year and try and give a better breakout of a run rate. We tried to give you an idea of a run rate excluding some of these things, and I think we will work hard toward giving you a run rate that incorporates the pluses and minuses.
But again I want to get back to Dave Fick's question, Michael in the aggregate. I would say that if our average development portfolio in most places of the world with the exception of Japan was probably in the, I don't know, I will just pick a number, 8.5 to 9-type range. And the only exception to that again Japan, and maybe to a lesser degree, the UK, it wouldn't be beyond us to be 5% to 10%, maybe as much as 15% off that number in terms of pro forma. But we were capitalizing interest at a much, much lower number than that. So I don't think that should be too much of a concern, in terms of covering that.
We will take a question from the web. From Cedrick LaChance of Green Street.
Cedrick LaChance - Green Street Advisors
You have made notable progress in deleveraging the balance sheet. What actions will you take to delever some of your co-investment funds? How can equity be added to these structures, given that your fund partners are no longer required to commit capital in many cases.
Yes. I think we walked through the debt maturities coming due in the funds. For all intents and purposes, we have taken care of 2009. In 2011, there are a smattering of relatively modest financings in about four or five of the funds, that are some of the older funds, that quite candidly, are well within reasonable loan-to-value ratios already. And I didn't touch on those, but I think we have demonstrated that we have the ability to refinance those types of things. We focused on PEPR and PEP II, which are the two biggest as it relates to 2010.
And PEP II, relative to its outstanding debt is about 2.8 times relative to unencumbered assets to total debt. We are pursuing secured financings. On those assets, we have got three deals that we have got executed term sheets on already. We have got another five packages out. But the whole intent in PEP II was to put in place a warehouse line, that over time would be taken out by secured debt financings. And we are in that process right now.
As I said before, PEPR, there is clearly a little more wood to chop on pepper. And it is experiencing some of the same phenomena that PLD and others experienced last fall which is you have a bunch of debt maturities coming up, how are you going to handle it? And we are incredibly focused on it. And we are handling it in a whole variety of ways by pulling the types of levers, in fact, that we were able to pull for ProLogis and pursuing it aggressively.
And so, we think we are pretty confident, that we will get through that tunnel the same way that we got through our own. And so we are pretty confident. But in terms of, some of the funds may need incremental capital. You have to look at that on a fund-by-fund basis. We have, in the past in one instance for debt maturities coming up this year, it is a $14.5 million maturity in 2009. We are going to use cash flow from the existing fund to repay that maturity. It is a small maturity. And in other funds, we may call a smattering of capital, here and there. Or use distributions.
Clearly inside PEP II, if the world were to decline precipitously, we have over $500 million of uncalled capital inside PEP II above and beyond our 2009 contribution expectations. So I think we have a variety of levers to deal with the fund financing environment. I realize, undoubtedly, these sound like big numbers. The fact is, it is over $20 billion of assets on demand. It is a big number. And so by the law of large numbers, we have dude a lot on an annual basis. And again, I think we have demonstrated that we have been able to do that in the past. The death and dearth of the financing environment is probably not as bad as some people think. We just have got to attack it aggressively.
Cedrick, I would make a comment, and we have talked to you about this in the past. It seems like it comes up continuously. And I understand it's an issue of concern in the market. But look, let's put things into perspective. Hopefully, once and for all. These are not opportunity funds that were 80% and 90% levered, in which case a 10% to 20% movement in value has completely wiped out the equity. These were funds that were roughly 50% levered.
And I know what you all do, you go to our supplemental, and you put an 8% or an 8.5% cap. Some of you, depending on how Draconian you want to get, even more than that. And you say, oh my gosh, now these funds are 70% to 75% levered. Well, most of the debt doesn't come due other than PEP II, which Bill has already addressed, and PEPR, within the next four or five years. And so you look at it and you say, okay, well wait a minute. What is the right cap rate that I apply to this thing, and if you apply roughly an 8% cap, you're probably 65% levered. Could you get that deal done? Is that able to be refinanced today? Yes, it probably is. But then you cut through to and you say, what is the cost per square foot relative to replacement cost for that fund that expires in four years or whatever it is.
When you cut through it, it's probably $45 a foot to $48 a foot in the US, EUR 55 a foot in Europe. Wow, that's 30% below replacement cost. Or 20% below replacement cost. What I don't want people to do is get too uptight about something that expires in two or three years that might take a little bit of equity from ProLogis and our partner to continue to go. You know what? It might. But we are not talking about something where the equity is completely wiped out. And if you really cut through and analyze the numbers, you are talking about refinancing something that is probably 20%, 30% below replacement cost in terms of its value.
Let's take a long-term perspective on this thing, which we are doing. And we are looking at it year-by-year. And we feel like we have made a whole lot of progress, not only this year, but toward our fund maturities next year. And we are going to deal with it.
We have another question from the web. This one from Michael [Hanes] at Beach Point Capital.
Michael Hanes - Beach Point Capital
Can you please address the fixed-charge coverage test in your credit facility? What do your internal models show with respect to how close you could come to violating those? Particularly, as in later quarters this year, you will have increasingly small contributions from trailing 12 months of development gains?
Let me touch on that. Really the fixed-charge coverage test, that if you look through our covenant disclosures in Q1. The one that might jump out at you is the global line which is 1.88 versus a 1.75 coverage test. A couple of things, relative to that. First of all, on the bond covenants, we don't anticipate any particular issues with the bond covenants. The fixed-charge coverages are at 1.5. We think through existing FFO and cash flow growth, etcetera, it's a non-event. On the global line, I think it came in at 1.88. And we have talked about this in the past, these covenants are very difficult to understand and get into. But in the grand scheme of things, the first thing you need to know on the global line is this 1.88, however, there is a provision in the agreement that says if you were to break that covenant, under current GAAP accounting, then you go back to GAAP accounting that was in place at the time that the line was put in. And in fact, the 1.88 includes the phantom interest expense associated with the converts. And so we have on an annual basis, an extra $60 million or $70 million of interest expense in that covenant. Call that, on a quarterly basis, maybe $18 million of interest expense in the 1.88. If you went back to old GAAP, the 1.88 goes up to a 2.08.
And so we feel a lot more comfortable in the grand scheme of things relative to the interest coverage ratio on that. Additionally however, and I briefly mentioned. Clearly, our intent is to bring the global line covenants more in line with the bond covenants. And so my desire and expectation is to bring the debt service coverage ratio to 1.5 in a revised bank deal. Just to make sure that we all have that room, that deal is not done yet, but we are working on it and focused on it. And that particular aspect of the discussions is not particularly controversial.
And I know it is about 10 o'clock, and there are about five or six other calls starting right about now. So, we'll take two more questions from the audience?
Scott O'Shea - Northstar Realty
Good morning. Scott O'Shea with Northstar Realty. A quick question on the monetization of the land bank, are there steps you can take over the next, 18, 24 months to work that down? Or, is it effectively mothballed until the next upswing?
Actually, there are steps we can take today, and we are taking them. There are still opportunities to sell land to users. There are opportunities to develop on a build-to-suit basis for users. We have done a few user sales already this year of existing buildings or pipeline buildings. I think we'll see more of that on a go-forward basis. There are joint venture opportunities on certain pieces of land where we bring in an investor to work with us on developing a property. There are build-to-suits for lease. One of which we are actually we just signed up where you can build a building. Bring in a take-out buyer and build it, and effectively sell it at completion where we wouldn't have the cap rate risk or financing risk associated with the transaction.
And then there are some deals that we will do where the land value is significant enough that we would put up the land, go out and borrow 50% loan-to-value. Build a building, hold it on our balance sheet, and collect the rent. All of those scenarios with the exception of the third party investor would include some sort of a build-to-suit, at this point in time. We don't intend to take development risks, speculative risks on leasing. As build-to-suits come, and there are actually several out there. We will try and monetize our land in one of those ways. And as we sit here today, there are probably five or six opportunities that we are working on. That we hope to announce throughout the year.
You know, Scott, and as I mentioned $100 million to $200 million. I really think that by the latter part of this year. That we'll have at least $100 million to $200 million of that $2.5 billion that we'll be either we will have sold or probably more likely, we would be generating a return on capital without putting our own capital in. And again, we will make announcements as they happen. But we are definitely working on it today. And I think that will accelerate in the next year.
Scott O'Shea - Northstar Realty
Hi, along those lines of land inventory. How much of your debt is attributable to just land inventory? And also last year, I thought you had $3 billion of land inventory in China? Is that gone now?
No. And none of the debt is attributable to the land. The debt itself, the land is on our balance sheet, and the debt is. It's not attributable to any piece of land. And no, we had about $254 million of land in China. Which when we sold our Chinese operation, the land went with it. And we took that out of the land balance.
And I think equally or maybe more importantly, we are not capping interest on our land. So as time goes on, that basis isn't going up. We are not taking any phantom FFO off the land. We recognize the land is going to be a challenge for us in this environment. It's a big challenge. But it is geographically diverse, and it is interesting to me to see when you are as diverse as we are, there are isolated opportunities with different customers in different locations around the world. And as Walt mentioned, I think we are going to see that start and slowly accelerate over time. I think it's going to take us a while to get through this land. It's not going to be nothing for the next two or three years. We'll start working our way through it really this year.
We would like to thank everybody for coming today and everybody that is on the webcast. Thank you very much. We look forward to reporting our progress in three months. Thank you again.
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