Prologis' (PLD) CEO Hamid Moghadam on Q2 2014 Results - Earnings Call Transcript

Jul.22.14 | About: Prologis (PLD)

Prologis, Inc. (NYSE:PLD)

Q2 2014 Earnings Conference Call

July 22, 2014 12:00 ET

Executives

Tracy Ward - Senior Vice President, Investor Relations

Hamid Moghadam - Chairman and Chief Executive Officer

Tom Olinger - Chief Financial Officer

Gene Reilly - Chief Executive Officer, Americas

Gary Anderson - Chief Executive Officer, Europe and Asia

Mike Curless - Chief Investment Officer

Analysts

Steve Sakwa - ISI Group

Dave Rodgers - Robert W. Baird

Brendan Maiorana - Wells Fargo Securities

Michael Bilerman - Citi

Vance Edelson - Morgan Stanley

Jamie Feldman - Bank of America

John Guinee - Stifel

Ki Bin Kim - SunTrust Robinson Humphrey

Craig Mailman – KeyBanc Capital Markets

Ross Nussbaum - UBS Securities

Vincent Chao - Deutsche Bank

Brad Burke - Goldman Sachs

Eric Frankel - Green Street Advisors

Michael Mueller - JPMorgan

Michael Salinsky - RBC Capital Markets

Operator

Good morning. My name is Steve and I will be your conference operator today. At this time, I would like to welcome everyone to the Prologis Second Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

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

Tracy Ward - Senior Vice President, Investor Relations

Thanks, Steve and good morning, everyone. Welcome to our second quarter earnings conference call. The supplemental document is available on our website at prologis.com under Investor Relations. This morning we will hear from Hamid Moghadam, our Chairman and CEO, who will comment on the company’s strategy and the market environment; and then from Tom Olinger, our CFO, who will cover results and guidance. Also joining us for today’s call are Gary Anderson, Mike Curless, Ed Nekritz, Gene Reilly and Diana Scott.

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

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

Hamid Moghadam - Chairman and Chief Executive Officer

Thanks, Tracy and good morning everyone. The second quarter was one of the best we have had in recent memory. Each of the three business plans contributed to our strong performance. With our portfolio repositioning now substantially behind us, our investment strategy is even more focused than before. We operate only in the best markets serving global trade and regional distribution.

The benefits of the strategy were evident in the following operating metrics. Our same-store NOI growth reached its highest level since the downturn. We have had six consecutive quarters of positive rent growth on rollover. Small unit leasing is up in the U.S. and we are seeing a surge in our value-added conversion business. On the capital deployment front, we started new developments with higher than average margins. We have a growing pipeline of opportunities and a land bank well positioned to serve the needs of our customers.

Turning to capital flows, we continue to see strong institutional interest for industrial real estate. As a result, cap rates continued to compress as evidenced in recent portfolio transactions. The impact of declining cap rates on our NAV is significant. In fact, we have seen cap rates compress about 25 basis points since our investor forum last September. This translates to more than $2 per share of NAV. The improving markets are also having a positive impact on our value-added conversion activity. This business is unique to several of our key markets that are subject to strong urbanization pressure. We believe our value-added conversion business is poised to produce meaningful gains and NAV appreciation as we convert some of our industrial properties to higher and better uses, particularly in the San Francisco Bay Area, which is benefiting from rapid growth of the technology sector.

Now, let’s turn to our co-investment activity, which is hitting on all cylinders. During the quarter, we recognized a significant promote for USLF. And we completed our IPO in Mexico. The FIBRA simplifies our structure and positions us for long-term growth in this important region. With this offering, perpetual life vehicles now account for about 95% of our third-party assets under management. We also expanded our relationship with our partner in China and raised new capital for open-ended funds in the U.S. and Europe. As our capital activity now includes both public and private sources, on a go forward basis, we will refer to this business as strategic capital to better describe the focus of these investment vehicles on specific segments of our business.

Let me conclude my comments with a few observations on the current market conditions. In the U.S. we see our customers being more decisive and proactive to commit to space in anticipation of growth, really for the first time since the global financial crisis. This demand stems from growing inventories, up 5% from last year in real terms and 3% higher than the prior peak. We are in the 17th consecutive quarter of absorption in excess of supply for industrial space. As a result this excess demand of vacancy continues to trend lower and at 6.8% is now the lowest level in 15 years.

In Europe leasing remains very strong in the UK, Germany, Netherlands and the Nordic region, while Southern Europe and a few markets in Central and Eastern Europe continued to lag, all our European markets have now turned the corner. In Japan, China, Brazil and Mexico we continued to see excellent leasing momentum. This backdrop supports our plans for growth as our development markets by and large have remained disciplined around margins and risk levels.

To sum it all up, the second quarter was one of our best ever. As we look forward, we believe the combination of rental growth, the profitable development of our land bank and the scaling of our platform set us well – it set us up well for an extended period of above average earnings growth.

With that I will turn it over to Tom.

Tom Olinger - Chief Financial Officer

Thanks Hamid. I will start with our results for the second quarter. Core FFO was $0.48 per share. Quarter end occupancy was 94.6%, up 90 basis points year-over-year. GAAP rent change on rollover was 6.6% led by the U.S. at 12.1%. Cash rent change on rollover was a positive 0.6%. GAAP same store NOI increased (3 points) in the quarter the majority of the increase was driven by occupancy and rent growth. Looking further into this metric, average occupancy was up 110 basis points versus the prior period, while 23% of our leases in the same store pool rolled over last four quarters at an average increase of 6%. We did benefit from some non-recurring items, mainly lower expenses which had a positive impact of about 70 basis points on our same store results for the quarter. On an adjusted cash basis same store NOI grew 5.3%.

Turning to capital deployment during the quarter, we continued to see development margins well above our historical average. Development stabilizations were $371 million with an estimated margin of 23%. We generated $82 million of our share value creation or about $0.16 a share. Development starts were $439 million with an estimated margin of 19%. We invested $412 million in building acquisitions and in our co-investment ventures. Contributions were $26 million and non-strategic building dispositions were $520 million totaling $546 million or $443 million our share at a weighted average stabilized cap rate of 6.6%.

As Hamid mentioned we closed our IPO in Mexico this quarter. The formation of FIBRA Prologis was not reflected as the contribution given our underlying ownership interest in those assets remained unchanged. We received equity certificates in exchange for our portion of the Mexican operating assets and hold a 45% ownership stake in FIBRA. This new structure allowed us to reduce the number ventures in Mexico with a permanent vehicle resulting in a simplified structure and lower G&A.

Moving to strategic capital, operating income was $48 million in the quarter, which includes $25 million of promote income from our targeted U.S. Logistics Fund. Switching gears to capital markets, we are taking every opportunity to secure long-term capital at today’s costs to enhance both composition of our debt portfolio and liquidity. In the second quarter we completed $3.6 billion of financings. We used the majority of the debt proceeds to retire over $1 billion of secured and unsecured debt in the second quarter and an additional $466 million in this month. The debt retirement was at near zero economic cost on an MPV basis. We now have no meaningful debt maturities until 2017.

The cumulative effect of our debt activity over the past 12 months has had a very meaningful impact on our balance sheet. We lowered the interest rate on our bonds by 160 basis points to 4%. We added 3.1 years to the average term of our bonds and 2.3 years to the overall debt stack and shifted U.S. dollar denominated unsecured debt to euro and yen increasing our U.S. dollar net equity to 85%. We accomplished of all this while building over $3 billion of liquidity.

Let’s turn to guidance for 2014. We are nearing the range for year end occupancy to between 95.2% and 95.8% and GAAP same-store NOI growth to between 3.25% and 3.75%. On net G&A, we narrowed the range to between $238 million to $243 million. Looking forward, we believe we can grow AUM with little if any incremental G&A. For capital deployment, we are taking our guidance up to reflect the current pipeline of opportunities we are seeing across our geographies. We are increasing development starts to between $2 billion and $2.3 billion, with 85% of our share and increasing building acquisitions to $1.3 billion to $1.6 billion with 45% of our share. We are lowering contribution guidance to between $1.6 billion and $1.8 billion, with 55% our share primarily due to timing. For dispositions, we are increasing guidance to $1.3 billion to $1.6 billion with 90% our share.

From a funding perspective, we have ample liquidity to fund our incremental net deployment. For strategic capital guidance, we are increasing the revenue range to $220 million to $225 million and expenses to $100 million and $105 million generating an operating margin of over 50%. These increases are results of the higher promote income and fees from the FIBRA.

I want to point out that strategic capital revenue in the third quarter will decrease due to the impact of the USLF promote in the second quarter. We expect our next promote to be in 2015. For FX, we are maintaining our assumptions for the euro at 1.35 and the yen at 105 for the second half of the year. We expect our U.S. dollar net equity to further improve and reach almost 90% by year end. Putting this all together, we are exceeding our forecast on all fronts. And as a result, we are raising our full year core FFO to range between a $$1.82 and $1.86 per share. This represents an increase of $0.05 at the midpoint and year-over-year growth in core FFO of 11.5% and translates to full core AFFO growth in the high-teens. The recent credit rating upgrades from Moody’s and S&P are further affirmation of our earnings trajectory and operational outlook. Importantly, we are well on our way to building one of the strongest balance sheets in the REIT sector.

In closing, we had great results for the second quarter with each of our business lines outperforming. Looking forward, we expect core earnings growth to accelerate as both rents and occupancies continue to increase and to properly capitalize on deployment opportunities across the globe.

With that, I will turn it over to the operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Steve Sakwa with ISI Group. Your line is open.

Steve Sakwa - ISI Group

Thanks. Good morning out there. I guess kind of a two-parter, but could you maybe just expand a little bit more on the development starts, it seems like the business is very back-end loaded. It sounds like you are pretty confident about that. How should we sort of think about the starts by quarter? And then I guess I was just wondering if you could get a little more color on the decline in the contributions and you say it’s timing related Tom, but what sort of can you tell us what’s going on there?

Tom Olinger

Yes. I will take the second part of the question first. So, it’s just due to timing of contributions, primarily in Europe that are going to move into the first quarter for a variety of reasons. It has nothing to do with the underlying performance of those assets. It’s just the timing of when those assets will move off our balance sheet.

Mike Curless

And Steve, it’s Mike Curless. Relative to the development volume, we had a late first quarter, but as expected and that was due to seasonality and mix primarily, but in the second quarter we had a substantial ramp up and we expect that for the balance of the year. We have increased our guidance range to over $2 billion. And we are highly confident in that when you consider 95% of the remaining work to do is identified and I contrast that with this time last year, we were 80% on that number. We think there is some bias to the upside on U.S. build-to-suit some activity in China. And in terms of the complexity or complexion of that work we will see over the year, 50% should take place in the Americas, 30% in Asia, and call it 20% in Europe and at the end of the day about 25% in build-to-suit. So, we are very comfortable with not only the length of our prospect list, but more importantly the strength of that prospect list.

Operator

Thank you. Your next question comes from the line of Dave Rodgers with Robert W. Baird. Your line is open.

Dave Rodgers - Robert W. Baird

Yes. Good morning out there. I did want to follow up on two things. I guess first talk a little bit about the investment in the NAIF fund in the U.S. Was that I guess in taking out an existing shareholder, was that just net growth capital, talk about your feeling about putting more money into the U.S.?

Hamid Moghadam

We like the values. It’s real estate we obviously know really well. And I think the ability to deploy capital in proprietary ways in portfolios that we know really well is exactly what we should be doing. We have done it over the years and there was an opportunity to do some more of it this quarter, yes. And by definition since the fund has not been raising new capital for growth, the only way that can take place in the particular fund is to buy out other investors. That may want to re-deploy their capital.

Operator

Thank you. And your next question comes from the line of Brendan Maiorana from Wells Fargo Securities. Your line is open.

Brendan Maiorana - Wells Fargo Securities

Thanks. Good morning. I am wondered if you guys could comment on the outlook for occupancy and compare that to what you are trying to do with rent spreads, it looks like on the occupancy increase at the midpoint of your guidance by year end is up about 100 basis points. But I think the expectation was that rent growth would start to materialize more meaningfully as we move throughout the year. So, do you still expect that rent spreads should move higher even though occupancy, it sounds like you expect to be significantly higher by year end as well?

Gene Reilly

Yes, Brendan, it’s Gene. I will start with that and Gary can comment the rest with geographies, but we do absolutely expect that rent spreads will continue to grow in the America. So, we are at 11.3%. And if you look over the past five quarters, we have grown that from 2% or 3% and at a pretty straight line up to that level. So, we think that will continue. We think in the U.S. we will have a chance for somewhat higher occupancies, but frankly, we have the teams now really focus on rent growth. So, those are the dynamics that play really throughout the Americas, including Brazil and Mexico. And I will turn it to Gary.

Gary Anderson

Yes. So, Brendan, in Asia as you know we have been bouncing around between 95% and 96%. And that’s right where we want to be. We are pushing rents in both Japan and China. And we expect that to continue through the balance of the year. If you look at Europe, we grew occupancies 30 basis points and we would expect to grow occupancies over the course of the year. Europe is a little bit of a mixed back as we have talked about before as Hamid said on the opener. UK is strong. Northern Europe is strong. Central and Eastern Europe and Southern Europe are lagging. So, in terms of rents spreads, we are able to push rents in those two key geographies and in the others we are not. If you look at this quarter in particular, about 75% of our leasing in Europe was in Central and Eastern Europe and Southern Europe. So, not an opportunity to push rents there. And as you go forward at least for the next two quarters, you see sort of about the same trend. So, we are not expecting any real rent growth out of Europe, but we will be getting it out of the Americas as Gene mentioned out of Asia.

Tom Olinger

Yes. The only thing I would add to what Gary said in Europe is that cap rates in Europe have compressed a lot faster than we thought when we put together our long-term rent forecast and obviously, declining cap rates are a headwind for rent growth. So, I would say rent growth in Europe is probably delayed by some period, maybe six months, maybe a year, but boy, cap rates have come in over 100 basis points in most of the continental market. So, I think it’s impact on NAV would be very positive.

Gary Anderson

Yes. And Brendan, just one other thing as Hamid pointed out at the beginning of the call. We think that all of the markets in Europe have bottomed and have turned in the right direction. And I think that Europe will actually be a tailwind for us going into and through 2015.

Operator

Thank you. Your next question comes from the line of Michael Bilerman from Citi. Your line is open.

Michael Bilerman - Citi

Yes. Good morning out there. So, I had a question in terms of the North American fund buy-in. If you take your $275 million of equity growth setup for the 19% stake and adding the debts, you get to a gross book value just under $2.6 billion, which would be about 6.5% effective cap rate on that capital that you put in. So, one I just wanted to understand, how does that 6.5% compared to what the NAV of the fund is in terms of this proprietary book that you talked about. My sense is it would be lower, but I wanted to sort to get, sort of your view, number one? And number two, how does that $275 million of equity, $480 gross in terms of the assumption of debt factor into the capital deployment on Slide 8. Is that in there or not? Thank you.

Hamid Moghadam

I will let Tom answer the latter part of your question, but 6.5%, your math is pretty close. It’s in that range, plus or minus some basis points. We acquired it at stated NAV, which is determined by third-party appraisers on a regular basis. But we see value in that NAV, as you know appraisals can lag, they can lead, but we know the portfolio well, you got to know what the mix of the assets is, which you don’t as well as we do. And we think that represents really good value and very inexpensive for business for us to pickup, because we are managing it anyway. So, we like those kinds of deals and we look forward to doing more of those kinds of deals at the right points in the cycle. Tom, do you?

Tom Olinger

So, Michael that investment was not reflected in our acquisition guidance. So, it’s not reflected as part of the number shown on Page 8 incremental to that.

Operator

Thank you. Your next question comes from the line of Vance Edelson from Morgan Stanley. Your line is open.

Vance Edelson - Morgan Stanley

Hi guys. Good morning. It looks like you expect stabilized development deals to even out globally by 2015 and beyond settling in around 7% versus the range by region we see today. That could suggest either you are not sure, so you just estimate everything will come out around the same or in your case I am guessing there is some good analysis behind it. So, how confident are you that the development yields will increase slightly in the Americas and Asia while coming down by a 1% or so in Europe.

Hamid Moghadam

I am not sure that’s the math, we don’t do it that way, put it this way. The way we do our development forecasting is that we have some bottom line numbers, bottoms up numbers from each region in terms of their pipeline, which is pretty visible at this point, certainly for the balance of this year and into next year. And we kind of know the economics of those deals plus or minus a little bit than we crank them in. So, it really varies depending on what the land is on the books for and whether that land was impaired, whether that land was acquired recently or a long time ago. So, it’s not as simple as just taking a region of the world and applying a yield to it and mixing it up. And really you need to get more granular than that and it’s pretty impossible for you guys to do that based on the information that there is out there.

Tom Olinger

And what’s more important, as Hamid was referring to is the margin, right. So, when you look at the margins that we are expecting on starts for this year, it’s going to be in the high-teens. And we have been stabilizing in the low 20s and we are going to continue to see the benefit of a land bank that’s under fair value – undervalued from a fair value perspective benefit our starts and our stabilizations with probably into 2016.

Operator

Thank you. Your next question comes from the line of Jeff Specter with Bank of America. Your line is opened.

Jamie Feldman - Bank of America

Great, thank you. This is Jamie Feldman here with Jeff. So, can you guys talk a little bit about the supply story and what you are seeing across the markets versus where you were last quarter or even at NAREIT, just in terms of supply risk? And then how you think that plays out to your expectation for rent growth, I guess even on a multi-year view, which you guys gave at the Investor Day for both rent growth and even the same-store outlook.

Gene Reilly

So, Jamie, it’s Gene. I will start with that. So, our view in the supply picture in the Americas really hasn’t changed over the last quarter. I mean there are three distinct markets that are sort of close to equilibrium, Houston, Dallas and Southern California. Some other markets, Baltimore, for example, has got a lot of supply coming on in line, but essentially it’s those three and not much has changed. And quarter-to-quarter, some have actually dropped in terms of quarterly starts, some have increased, but it’s – more importantly, I think you need to look at what’s happening in the big picture, what’s in that pipeline and how is that compared to absorption. We are pretty comfortable frankly that overall Dallas and Southern California still have excess demand. Now, there are certain submarkets of Dallas, South Dallas in particular that we think are oversupplied. And I think we talked about that last quarter. Houston has a little bit of excess supply, but frankly, we stabilized two buildings in Houston this quarter, almost 300,000 feet, it’s 100% leased and we will continue to build product that’s core for us in Houston. And that’s going to be catered to 30,000 to 100,000 square foot tenants. Demand there is still pretty robust. So, again, that’s a long way of saying not much has changed.

Relative to the second part of your question, I think it’s the replacement cost rents. How is this really going to affect the rent picture? And let me give you sort of big picture what we say happening in the U.S. Over the last year, let’s say, we think that the cost of construction, essentially the hired cost have grown around 6%. We think land values are up around 12%. And you have had some cap rate compression. And if you mix that all together, replacement cost rents are growing at sort of 2% to 2.5% over that period of time. Over the next year, we think replacement cost rents are going to grow more like 5%, because we don’t frankly, you don’t have the cap rate compression in the equation as of right now. So, there are certain submarkets I mentioned South Dallas, where we are going to have headwinds on the rent growth. But overall, we remain pretty bullish about it throughout the Americas.

Tom Olinger

So, Jamie really quick on Asia and Europe, if you look at China, again, tremendously undersupplied today. I think our rent change on roll this quarter came in the low-teens. We have projected call it 6% market rent growth over the next four years or so and we are exceeding that. Japan again still undersupplied. We are seeing pretty greater rent growth than we had originally anticipated. It’s coming faster in Japan. You will see a little tick up in vacancy rates in the Tokyo market this coming quarter, maybe up to 5% or 6%, but again not a concern. Moving to Europe, we are still undersupplied in Europe. You don’t really see new starts, but for build-to-suit starts, there maybe a handful of spec buildings than just a handful of sub-markets. And I think in Europe, we have seen again 11 consecutive quarters of positive net absorption. So, we are really in pretty good shape there as well from a supply standpoint.

Hamid Moghadam

Jamie, to tie back to the last Investor Day, I think we are right on track. If anything we are a tad ahead in terms of timing, particularly in the U.S., we are a tad behind in Europe, because of that cap rate compression that we talked about, but generally, if you mix – and we are ahead in Japan for sure. So, China is about on target. So, if you mix it all up together, I would say we are on or slightly above plan given the size of the U.S. and on the same trajectory as we had nine months in a row whenever we did that.

Operator

Thank you. Your next question comes from the line of John Guinee with Stifel. Your line is open.

John Guinee - Stifel

Great, thank you. Nice quarter guys. Quick question, if I look at your development spreads, is that before or after taxes and how are you guys handling just very complicated corporate tax differences between countries?

Tom Olinger

It is an after tax margin. So, we reflect all taxes in there. And in the vast majority of the cases, the actual tax that’s embedded in those margins is fairly modest, because we have the ability to – if we are contributing an asset into a fund to do it on a highly effective tax manner to minimize taxes. And then upon sale, any taxes are typically transferred or shared, because they are typically entity sales, so the tax on that is pretty modest.

Operator

Thank you. Your next question comes from the line of Ki Bin Kim with SunTrust Robinson Humphrey. Your line is open.

Ki Bin Kim - SunTrust Robinson Humphrey

Thank you. Can you just talk a little bit more about your lease spread commentary, I think you said 35% of the leases that were signed in Europe are Central Europe, is that the case next year and what does that mean or imply about the lease spreads overall that you might be seeing when you look out further than just the next couple of quarters?

Hamid Moghadam

Okay, so in Europe it’s hard to say what the future is going to be exactly because we don’t know what will be leased, but this specific quarter 73% were in Central and Eastern Europe and Southern Europe. As you look forward for the next two quarters the lease expirations that we see, so that obviously doesn’t complete new leases, but the lease expirations are in that same sort of range. So I would expect that you won’t see again a substantial contribution from Europe at least for the next two quarters in terms of rental growth. But I do expect as we push occupancies up into 2015, that Europe will begin to contribute more so than it has in this quarter.

Tom Olinger

Ki Bin this is Tom, from an overall trending perspective looking into next year, when you look at our lease expirations and we show that on Page 22 of our supplemental. You can see on an our share basis, rents rolling next year at 529 a foot. Overall portfolio is at 550 a foot. We think today in place to market is about 90%. So we are under – our portfolio is under leased by about 10%, but when you look specifically 2015, it is more than 10% under market. And that’s just the composition of the roll. The vast majority of the leases that are rolling in the next few years are post prior peak periods, a lot of them during the crisis. So you are going to see more than that a 10% mark to market on leases that are rolling into next year.

Operator

Thank you. And your next question comes from the line of Craig Mailman with KeyBanc Capital Markets. Your line is open.

Craig Mailman – KeyBanc Capital Markets

Just two quick ones, on same store NOI, you guys had a nice accelerating trend last couple of quarters, but you have also been helped out a little bit on the expense side, does that become a headwind at all in the current kind of the trend in the second half of the year. And then this is second question, can you guys just talk a little about the turnover costs this quarter and whether that’s just skewed by a couple of leases or a more of a kind you guys are seeing?

Tom Olinger

Craig this is Tom. It’s not going to be a headwind for us as we look at same store in 2014 or 2015, a lot of the expense benefits that’s going on are just where we are in the cycle, lower bad debt expense, other lower slippage just via higher occupancy. So I don’t think it’s a trend that impacts us going forward.

Hamid Moghadam

And related to the turnover costs, we are doing more small-unit leasing right now, that’s what’s vacant in the portfolio, and that has higher turnover costs associated with it. We also had a higher ratio of new leases to renewals, and new leases have a significantly higher turnover costs. So those two things sort of gave us a little bit of a spike this quarter. I think the best that for you look at is the turnover costs for the value of the lease, so that’s 9% this quarter. I don’t think it will stay at that level. I think it will come down. But we will continue to have higher volumes in the small unit leasing going forward.

Operator

Thank you. And your next question comes from the line of Ross Nussbaum with UBS Securities. Your line is open.

Ross Nussbaum - UBS Securities

Alright. Thanks. Good morning guys. Can you talk about the $1.8 billion of land on the book, so I am a little curious if I divide it up between the U.S. and Europe, how much of the U.S. land is what I would call legacy from the last cycle and how much of it’s been bought in the past couple of years. And maybe the same question on Europe, although I am assuming most of the land in Europe is legacy, where I am going with this is I am trying to sort of figure out if you look at the value per acre, which say in the U.S. is like 140 grand an acre, how that book value compares to where you have been buying land lately? Thanks.

Hamid Moghadam

So the vast majority of it is old land because first of all you say in the last couple of years, the land market didn’t really start moving until about 6 to 12 months ago. So there was very little liquidity in the land market, not a lot of trades in the land market. So I think you really by couple of years ago, you mean last year and by definition that’s couple of hundred million dollars of land acquisition that has not been put in production and has gone into the land bank. So I would say 80-20, so 80% of it is old land, 20% of it is new land. That’s not a scientific number, but it should be directionally correct. Mike any additional color on that?

Mike Curless

Yes. Another thing, I think it’s important to point out is the land that we have purchased here in the last couple of years worldwide, some 90% of that is at a building put into production right off the bat within – I am sorry within the first 18 months. And you see in Japan that line gets put into production, sometimes a week after we buy it. So, I think we are doing a really good job there of managing our land bank going forward.

Operator

Thank you. And your next question comes from the line of Vincent Chao with Deutsche Bank. Your line is open.

Vincent Chao - Deutsche Bank

Hey, guys. My question has been answered. Thanks.

Operator

Thank you. Your next question comes from the line of Brad Burke with Goldman Sachs. Your line is open.

Brad Burke - Goldman Sachs

Hey, good morning guys. I wanted to talk about development more, it just looks like this quarter saw a slight decline in your expected margins on new starts versus where you have been at for the past year or so. And I realized they have been telling us that we can’t continue to expect 20% plus development work. I was hoping you could elaborate on whether there is anything specific that would push these margins to a more normalized rate, because it sounds like rental rates continue to surprise you to the upside or is one quarter just future operating make any conclusions about the trend in development margin?

Hamid Moghadam

The latter.

Brad Burke - Goldman Sachs

Okay.

Hamid Moghadam

I mean, I can give you a longer answer, but it’s the latter. And that number will come down to about 15%, but it will take a few years, because we got to work through this old land before it does come down.

Operator

Thank you. And your next question comes from the line of Eric Frankel with Green Street Advisors. Your line is open.

Eric Frankel - Green Street Advisors

Thank you. You are talking little bit earlier about the release of spreads in the rent growth trajectory, can you just maybe touch upon the vintage of leases that are rolling over now maybe the percentages that were signed post 2009 and pre-2009? Thank you.

Hamid Moghadam

Yes. So, Eric, let me start with Q2, the leases that we signed in Q2 this quarter 5% of them were signed before June of 2008, 95% of them were signed after June 2008. And of those after 2008, 35% were in the trough. Okay. If you look at our overall portfolio as of June 30, 15% were signed before June 2008, therefore 85% signed after, 30% during the trough. So, net-net, we think we have got a pretty good runway of below market leases rolling for the next couple of years. So, one other factor that I want to bring in, this would be a good time as follow up to Eric’s question to make you all aware of. I think it scratched my head quite a bit as to why consistently the same-store NOI forecasted that you guys put out are low in this improving part of the cycle. And I think we have not done a good job of communicating something that happens to our business, which I want to just outline for you.

Basically, if you take our rollover schedule on an annual basis and just let’s make it simple, let’s say, we are signing 5-year leases and on average 20% of the portfolio rolls over. That understates the real rollover and the ability to move up rents at the good point of the cycle by about 30%, maybe a little more than 30% at times. So, the theoretical number of rollover is 20%. The actual number in a given year maybe 25%, 26% of the overall portfolio and that number is about 30% in the good part of the cycle, because the lot of tenants that need more space, less space, different kind of space and they have old leases, they come to us and they say we’d like to turn up that lease, we’d like to take the expansion space. We would like to do something different than when their lease technically expires. And of course so far in an up-market we like doing that, because we can get their space back and lease it up at the higher rent and lease some new space at the higher rent. So, in a rising market, the turnover statistic understates our opportunity to capture upside in rents.

Now, you might ask what happens in the downturn. In the downturn, does it go the other way? It doesn’t really, because unless there is a default, we are not going to write down the rent to market in case of a voluntary early termination of the lease. So, there is – the portfolio has a quicker ability to adjust to the upside when rents are escalating as much as they are now. And once you include that in your analysis, I think you will get a lot closer to the kind of same-store numbers that we have been talking about and finally getting close to achieve it. So going forward, don’t be surprised if your turnover ratios going back into the same-store NOI that you will see coming through in our portfolio.

Tom Olinger

So, an example of that would be the same-store pool for the last four quarters, we turned 23% of our same-store leases.

Hamid Moghadam

Anyway, I hope that helps.

Operator

Thank you. Your next question comes from the line of Michael Mueller with JPMorgan. Your line is opened.

Michael Mueller - JPMorgan

Thanks, hi. It seems like you are seeing more acquisition opportunities. I was wondering what you think is driving that and is there a regional bias to it?

Hamid Moghadam

We are seeing more acquisition opportunities in two places. One, what we talked about some proprietary deal flow through our funds. And by the way, we don’t do every deal that becomes available in our funds either. We only do it when we see value. I mean, there are cases where there has been opportunity to deploy more capital in our funds and we have just not availed ourselves of that opportunity. The second place is Europe, while cap rates in Europe have compressed rapidly faster that our expectations. We still think there is another 6 to 12 months of cap rate compression left in Continental Europe. So, don’t be surprised to see us be a pretty active acquirer of assets in Europe at below replacement cost. So, those are the two places I would guide your attention.

Operator

Thank you. Your next question comes from line of Michael Salinsky with RBC Capital Markets. Your line is opened.

Michael Salinsky - RBC Capital Markets

Good afternoon. Hamid or Gene, could you talk a bit about the strengths you referenced in the small bulk space, you got to put a little bit of numbers, what kind of spreads are you seeing on small bulk renewal right now versus some of the bigger bulk space?

Gene Reilly

Yes. It’s Gene. That’s a good question. So, in small unit leasing, we’ve increased occupancy pretty substantially all over the last couple of years. But we’ve got to ways to go so we’re in the Americas 92 and changed. But the real story is the rent spreads. We are over 12% rent spreads on small unit leasing this quarter. And that’s had a nice run like the rest of portfolio over the last four quarters and we think that will continue. So, you think about replacement cost analysis for these small units. We are way below placement cost rents right now. So there is actually more upside in that segment so, we believe that’s going to continue.

Hamid Moghadam

I would say just we have got the similar focus in small spaces in Europe, but we just don’t have the pricing power at this point in time. So, we need to get to a place where the Americas is, we are plus 90%, 92% in that segment, start pushing rents in that segment, but we are not there yet.

Operator

Thank you. (Operator Instructions) Your next question comes from the line of Michael Bilerman with Citi. Your line is opened.

Michael Bilerman - Citi

Thank you. So, I just wanted to follow back up just in terms of the ample liquidity. Tom, you talked about, where you talked about, there was obviously an increase in the net deployment, I think net deployment today is $200 million I take it that the contributions following into the first quarter of next year which is about $400 million or 50% share would effectively take care of that. But then I guess how should we think about the increase in the fund which is gross capital equity plus your share debt about $480 million, how should we think about your desire to deploy and it’s actually increased funding where you’re going to get that liquidity from with the goal of continuing to improve the balance sheet?

Tom Olinger

Going forward as you said when you look at the match funding for 2014, it’s really in line because when you look at starts down translate into cash flow. So, from a cash flow perspective, you talked about the net $200 million is actually much smaller, it’s actually about the same from the net cash flow perspective. And then we have contributions coming in the first quarter as well as an expected – expectation that we would see continued contributions stabilized – development stabilize and roll off. So, I think we can mostly self fund, going forward at this stage and any incremental capital of longer term we’re going to finance in line or capitalized in line with our long-term goals, which are mid to low 30%.

Hamid Moghadam

Yes. The only thing I would add to what Tom just said is that we are going to obviously as we mentioned earlier in the year and we continued to want to take advantage of a good disposition environment for selling a little bit of remaining non-strategic assets that we have. So we are stepping on the gas in the back half of this year and early next year to do that, so.

Operator

Thank you. And your next question comes from the line of John Guinee with Stifel. Your line is open.

John Guinee - Stifel

Great. Going out – looking at your Japanese REIT and your public vehicle in Mexico, is it possible to understand how those entities are trading on an implied cap rate basis right now?

Hamid Moghadam

I think that Japan number I haven’t looked at it in a while, it’s in the high-3s and the Mexican REIT is in the mid to high-7s. What I mean is that I have to listen to their calls too to figure that out…

Operator

Thank you. Your next question comes from the line of Jeff Spector with Bank of America. Your line is open.

Jamie Feldman - Bank of America

Thanks guys. It’s Jamie Feldman again. So Tom I am wondering if you can just walk us through the changes – the change to guidance at the midpoint in terms of what were the main moving pieces. And then as we think about FFO for next year, how much of that is recurring and how much of that is more one-time in 2014?

Tom Olinger

Okay. The $0.05 bump was primarily deployment, net deployment, some outperformance from the first half as well as stronger our share of operations and interest savings that would make up the S$0.05. What I see from a year-over-year run rate basis, I don’t see any of those being non-recurring. We obviously had a large promote in the second quarter. And we believe that we are going to see promote levels pretty consistent if not better than we have seen in the last two years going forward. At this point in cycle we feel very good about our promotes that we are going to be earning over the next three to five years. So I don’t see anything that’s in our results either year-to-date or in our forecast that are meaningful at all from a non-recurring standpoint.

Hamid Moghadam

Yes. And the only thing I would add to that is that if you go back and look at our investor presentation from last September, we had laid out some numbers for you that took into account sort of the rental picture and its growth. And as I mentioned earlier, in response to your question, we are on track or maybe a little bit better than that. So basically if you look at that forecast and say if you are going to redo that forecast how would you change it, I would say on the rental side we are pretty even. We have done a better job on managing our interest expense than before. And I think we have done a better job on G&A. And I think on both of those we are way ahead of the plan. So I would say, those numbers are pretty good with an arrow up on them directionally.

Operator

Thank you. And your next question comes from the line of Michael Bilerman with Citi. Your line is open.

Michael Bilerman - Citi

Just last question, just on the promotes and Tom you just touched on this, next year you have the opportunity to earn for the funds to promote, it’s about 35% of the assets in funds or in listed companies almost about 55% of your equity committed to those, can you give us at least based on where the NAVs are today, what that gross number promote potentially could be for ‘15 as we think about the FFO impact?

Tom Olinger

That would not be a good idea. First of all we don’t really know with any precision and secondly values can change around and it depends not only on the value that we think but the value that the appraisers thing etcetera, etcetera. But let me go back to something that I have mentioned to you over the years. I think our gross promotes is on the order of 25 basis points of third-party assets under management across the cycle. It will be lumpy, but that’s about what it works out to be across a normal cycle in terms of magnitude. Now from that you need to net out some things and get to a net number that hits the books. But so if you are going to use a number I would use maybe 15 basis points to get to the net number.

Hamid Moghadam

Michael when you look across the last two years we have put up $0.04 in ’13. We just put up $0.15 promote in ’14, I don’t think those numbers are out of line when you look at the next 3 to 5 years. I am sorry $0.04 in ‘13, $0.05 in ‘14.

Tom Olinger

Yes, which by the way $0.05 is $25 million, and if you look at our third-party assets under management at about $20 billion it gets to that mid-teen ‘15 net number that I mentioned to you. It is a little bit lower than that. But that’s not a bad number for sort of a recurring kind of flow, adjusting the lumpiness.

Operator

Thank you. Your next question comes from the line of Eric Frankel with Green Street Advisors. Your line is open.

Eric Frankel - Green Street Advisors

Thanks. Tom can you just go through the debt repurchases and just explain what exactly you mean by purchasing everything on a MPV basis that’s meaningless or not meaningless, or have no economic cost? Thanks.

Tom Olinger

Yes. So when you look at, so what we analyzed the economics of retiring debt early, we MPV that interest expense the reaming interest expense on that debt and we discounted back at our cost of capital, our cost of debt for that remaining term. And if that MPV is within 1% of the balance of that debt, we believe that’s a good economic deal because less than 1% is a pretty de minimus amount to pay for the viability to lock in long-term rates. So another way to look at it is if we could take that 1% delta and just amortize that over the remaining life of the debt, we think that would be maybe 10 bps a year. So it’s a very de minimus and we think that’s a very inexpensive price to pay to lock in today’s long-term rates. I mean in the last 12 months we have locked in 10-12 year debt, albeit euro but we had the ability to issue it at sub-3%. We will do that all day long. And we will continue to look at ways to do that, although that pool is diminishing rapidly, but we think it makes a lot of sense to do that.

Operator

Thank you. Your next question comes from the line of Ki Bin Kim with SunTrust Robinson Humphrey. Your line is open.

Ki Bin Kim - SunTrust Robinson Humphrey

Thanks. Just a couple of quick follow-ups here. What is the average contractual rent step up in your entire portfolio. And second part, your cash same store NOI growth has been outpacing your GAAP, is that just truly because more than normal burn off of rent and should that be closer going forward?

Tom Olinger

Yes. Ki Bin this is Tom. So from a contractual bumps globally about 80% of our leases have contractual bumps on revenue of I would say approximately 2.5%. So again that’s on revenue not on NOI. And the rest of our leases that don’t have contractual bumps typically have some sort of an indexation. So it’s like a CPI inflator. So you can’t straight line it but it does give you a bump every year. Your other question really is when will, yes cash NOI is outstripping GAAP today because of largely because of concession burn off and other, basically concession burn off. Those two are going to converge over time, over long period of time. They should be identical. I would expect they would converge and get very close to each other sometime in the back half of ‘15, early ‘16.

Hamid Moghadam - Chairman and Chief Executive Officer

Okay. Great, that being the last question, I just wanted to thank you for participating in this quarter’s call. And look forward to seeing you at the next call, if not before. Bye-bye.

Operator

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

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