AMB Property Corp. Q3 2007 Earnings Call Transcript

AMB Property Corp. (AMB)
Q3 2007 Earnings Call
October 17, 2007, 01:00 PM ET

Executives

Tracy A. Ward - Director of IR
Hamid R. Moghadam - Chairman and CEO
Thomas S. Olinger - CFO
Eugene F. Reilly - President, North America for AMB Property
Guy F. Jaquier - President, Europe & Asia for AMB Property

Analysts

David Fick - Stifel Nicolaus
Michael W. Mueller - J.P. Morgan
Christopher Pike - Merrill Lynch
Michael Bilerman - Citigroup
David Harris - Lehman Brothers
Jamie Feldman - UBS
John Stewart - Credit Suisse
Michael Muller - JP Morgan
Sloan Bohlen - Goldman Sachs
Cedrik LaChance - Green Street Advisors
Mitchell B. Germain - Banc of America Securities

Presentation


Operator

Good afternoon. My name is Kimberley and I will be your conference operator today. At this time, I'd like to welcome everyone to AMB's Third Quarter 2007 Earnings 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.

I would now like to turn the call over to Ms. Tracy Ward, Director of Investor Relations. Please go ahead.


Tracy A. Ward - Director of Investor Relations

Thank you Kimberley. Good morning and welcome to AMB's third quarter 2007 earnings call. I am Tracy Ward, AMB's Director of Investor Relation. Before we begin, I would like to remind you that this call is the property of AMB Property Corporation and is being recorded. The speakers' on today's call will make various remarks regarding future expectations, plans, and prospect for the company such as those related to total expected investments and acquisition and development, size and timing of contribution and dispositions, deliveries and total investments on development project or private capital business, aggregated development profits, future fund formations, expected earnings and our future business plans. These remarks constitute forward-looking statements for purposes of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. AMB assumes no obligation to update or supplement these forward-looking statements. Such forward-looking statements involve important factors than could cause actual results to differ materially from those in forward-looking statements, including those risks discussed in AMB's December 31, 2006 10-K and June 30, 2006 10-Q, which are on the file with the SEC. Reconciliations from GAAP financial measures to non-GAAP financial measures are provided in the supplemental analyst package, which is posted on the company's website at amb.com.

We will begin today's call with remarks from Chairman and CEO, Hamid Moghadam, followed by Tom Olinger, Chief Financial Officer, who will provide an overview of global operations, a review of financial results, and comments on our financial outlook before we open your call for questions. Guy Jaquier, President Europe & Asia; Eugene Reilly, President of America's; John Roberts, President, Private Capital are also here with us today.

I'll now turn the call over to Hamid.


Hamid R. Moghadam - Chairman and Chief Executive Officer

Thank you Tracy and welcome everyone to our third quarter earnings call. This is special time in the history of AMB as a public company. Next month, we will mark the 10th anniversary of our initial public offering. I would like to take a few minutes to review our accomplishments at this important juncture.

Since our IPO, we've delivered total annual returns of over 17% per year to our stockholders. This return has been about 490 basis points a year, ahead of the Morgan Stanley lead index over the same time period. Adding, the results of the last 10 years to our equally strong track record, as a Private Investment Manager active since the mid 80s, AMB's shareholders and private capital partners have enjoyed the very best performance in the industrial asset class anywhere for over 20 years. Looking back, our results flow directly from our focused investment strategy that positions us in the best markets tied to global trade and in locations where long-term demands exceeds supply. While these markets are often more challenging to enter, to build in, and to operate in, they have also been the most attractive places to invest over multiple business cycles.

As we shared with you at our recent analyst forum in New York, total returns, occupancy levels, and brands in AMB's target markets have outpaced other markets over the long-term. Now, with the global operating platform, we can serve the needs of our customers, looking to grow their businesses with a reliable and experienced operator, who can deliver high quality product in the right location and at the right place. At the same time, we are well positioned to provide our investor partners, the opportunity to invest with an aligned operating partner, offering the very best class, private capital vehicles around the world. We are able to do all this because our businesses are led and managed by carefully assembled team of talented local real estate professionals in 15 countries.

Turning to the third quarter, the benefits of our long-term strategic focus are evident in the strength of our quarterly operating results. Same-store NOI was up for the eight consecutive quarter. Our strategies delivered measurable organic out performance overtime. We've now posted five consecutive quarters of rent increases on lease rollovers and at 95.5%, our quarter end occupancy is well ahead of our projections and 470 basis points above the national average. We've also made significant progress building our global capital deployment platforms from the standing start in 2002. By year-end, we expect to generate over $0.5 billion in economic gain against the cumulative overhead investment of about $130 million. Our co-investment funds expand the globe with established vehicles that enable us to grow our businesses in North America, Europe, and Asia for many years into the future. Our current development pipeline stands at about 17 million square feet with 60% of it outside the U.S. And we own a growing land bank that can support an additional build out of over 42 million square feet.

During the quarter, we continue to expand our global reach. In China, we entered the growing port of Ningbo with a 16 acre development project totaling 400,000 feet. We're the first industrial developer to enter this strategic port market, which is approximately 7 million TEU's, is about 40% larger than the ports of New York and New Jersey.

We have now officially started up in India by forming a local partnership and completing our first key-in country hires. We are very excited about the opportunities that lie ahead for us in India, and we will have more to share with you in the coming quarters. Our entry into the UK represents our seventh European market expansion since entering the region in 2003.

Our first investment is a strategically located development project in Greater London and yet another example of our approach to build platforms patiently and from the ground up. At our September investor forum, we shared with many of you our value added conversion business plan, which we think is unique and results from our long-term focus on infill locations in many of the world's most vibrant urban markets.

We think this business has the potential to produce $30 million to $50 million of annual gains from the redevelopment of some of our industrial properties into higher and better uses. During the quarter, we disposed one such project and identified another as available for sale.

I would like to say a few words now about our private capital business. As I mentioned earlier, we have an exceptional track record of performance for our investors spanning many-many business cycles. In the last ten years, our private capital assets under management and fee revenues have grown at 30% a year, the former to $9 billion including $2.6 billion of investment capacity. Demand for industrial private capital investments remain robust and institutions seek to place funds with partners of long and strong track record of investing.

We enjoy access to direct institutional relationships that spans our 24 years of private capital investment activity. I would like to conclude my remarks this morning by offering a field observations on the current economic environment. With an environment focused on the sub-prime and liquidity concerns, the U.S. economy continues to expand, supported by the growth and employment and a vibrant global economy.

Retail sales remain strong at 3.8% year-to-date, although we anticipate a bit of a slowdown in the fourth quarter. Total business inventories are up a little from their record lows but at these levels even with a slowdown, inventories may need to increase further to support further economic growth. Import volumes are growing at a more moderate pace than last year but consumption...with consumption holding up, we would expect to pick in imports in 2008.

Direct communication with our customers indicate that while they are keeping a watchful eye on the U.S. economy, their global expansion plans remain intact as the import growth continues and U.S. exports are accelerating because of the weakening dollar. In short, we expect 2007 absorption of industrial space in the U.S. to continue to exceed new supply to the end of the year and in to 2008. In this environment, vacancy rate should continue to trend down albeit at a modest pace.

Moving outside the U.S. global trade continues to expand vigorously as evidenced by the loaded containers for export are growing by double digits in addition to the 33% plus year-over-year growth in trade volumes between Europe and Asia. We believe we are well positioned within this environment as strong growth in global trade translates into solid demand for first class distribution facilities in key port and airport markets around the world.

With that let me turn it over to Tom.


Thomas S. Olinger - Chief Financial Officer

Thanks Hamid, before we go underway I want to make you aware that we would be amending our 2006 10-K and our 2007 first and second quarter 10-Qs in the next week. These amendments are related to some additional disclosures we would be providing related to our unconsolidated joint ventures.

The amendments are the result of the SEC clarifying its view in the third quarter of how to determine the significance of unconsolidated joint ventures for disclosure purposes under rule 309. Again none of our financial statements are changing, we are just providing additional disclosure.

Now moving on to the third quarter, we posted a very strong results for the third quarter driven by significant contributions from our global core operations, development, and private capital businesses. Core operations across our global markets continue to be very solid with high occupancy, solid leasing activity, appreciable rent growth, and robust same store NOI growth.

Looking at the dynamics of the few of our principal global markets, fundamentals remain healthy in Southern California with market wide availability of less than 5% and actual vacancy below 2%. Demand in the San Francisco bay area continues to be strong with third quarter rents up 5% to 10% across almost all of the bay and 10% to 20% year-over-year. Leasing concessions continue to be virtually non-existent given the demand for space. In Europe, increased trade volumes with Asia, coupled with increase imports from the U.S. due to the weaker dollar is driving demand and opportunity, specifically in our Amsterdam, Hamburg, and Rotterdam markets. Paris, our largest European market continues to be healthy with 6% vacancy.

In Japan, leasing activity remains strong and rents are firming. Occupancy in our markets is above 95% and newly delivered space, continues to be absorbed at a solid pace. It also appears that due to a slowing pace of new office and residential project starts, construction costs maybe softening a bit. This could help offset some of the margin impact of rising land prices.

Now, turning to the third quarter results for our global operating portfolio, both quarter end and average occupancy remains strong at 95.5% and 95.4% respectively. Although, quarter end occupancy dropped 60 basis points from the strong quarter, almost all of the decrease was driven by acquired vacancies primarily in Paris and Singapore. Average occupancy remains strong, increasing 50 basis points over the strong quarter due to better leasing and retention than we forecast. During the quarter, we leased more than 6.3 million square feet of space with trailing four quarter tenant retention just under 73%. The third quarter marked the fifth consecutive quarter, rent increases on rollovers with an increase of 8.9%. Year-to-date rent increases on rollovers were 4.5% driven by Seattle, South Florida, and Southern California.

Our year-to-date rent increase growth is being leaded by San Francisco, as we discussed last quarter rent roll downs in San Francisco are the result of a few leases that were entered at market peaks several years ago. Currently, rents in the bay area as discussed earlier are increasing significantly and we'll be a driver of rent growth in the portfolio in the coming years. If we exclude the San Francisco market, rent growth for our global portfolio would have been 5.9% year-to-date. The third quarter also produced another period of healthy same-store NOI growth of 5.3% with year-to-date growth at 5.8%. The year-to-date same-store NOI performance was primarily driven by South Florida, New York, New Jersey, and Southern California.

Increased average occupancy as well as higher contractual rates contributed to both quarter-to-date and year-to-date performance. Looking at our capital deployment in the quarter, which totaled nearly $350 million bringing our year-to-date, totaled $1.4 billion. We continued to grow our business organically during the quarter by acquiring nine properties, $416 million, expanding our presence in four countries, $98 million of which was acquired for our private capital funds. With over $750 million in acquisitions year-to-date, we are well on our way of achieving our 2007 plan of $900 million.

We had 2.8 million square feet in new development starts in the quarter, comprised of 11 projects for an estimated total investment of $233 million. Our year-to-date development starts totaled about $688 million. The pace of worldwide leasing across the development pipeline is very strong as we released 2.2 million square feet during the quarter. Our global development pipeline now stands at 1.6 billion in 51 projects including four value-added conversions and is diversified across 11 countries in North America, Europe, and Asia.

At quarter end, the aggregate development profit margin of our development pipeline is approximately 23%. Aggregate development profits and aggregate development profit margin include gains in our pipeline from developments, value-added conversions, repositions, and land sales but exclude the divert portions of these gains.

On the private capital side, we contributed three development properties to the Europe fund and one property to the Japan fund with values totaling $280 million. Including the acquisitions discussed above, total deployment by our funds in the quarter was over $315 million. As of the end of the third quarter, 58% of our operating and development portfolio was held through our ten co-investment vehicles.

Moving to capital market activity in the third quarter, we brought back approximately 1.1 million shares of our common stock at an average share price of $49.87 or $53.3 million. We currently have about a $147 million of capacity remaining under our stock repurchase program. Despite the recent turmoil in the credit markets, we continue to be able to place debt at attractive rates. We obtained almost a $150 million of debt for our domestic portfolio of rates nominally higher than debt originated earlier in the year as increased mortgage spreads were offset to some degree by the reduced rates on U.S. treasuries.

Outside the U.S., we obtained approximately Û90 million and 6.2 billion yen of secured debt at rates relatively consistent with those earlier in the year. Also during the quarter, we paid off $55 million of medium term notes, which matured and had a coupon 7.9%. Our balance sheet continues to be strong providing the foundation to fuel the significant growth of our global development business, to fund global acquisitions, and to warehouse assets for our private capital business.

Now let's take a look at our third quarter earnings performance. FFO per share was $0.99, $0.21 above the top end of our guidance. We exceeded our guidance as aggregate development profits were higher by $0.14 due to higher than anticipated margins. We delivered aggregate development profit margins of 34.7% during the quarter. Core operations were higher by about $0.03 driven by... primarily by higher average occupancy and rent growth. We had about $0.05 of FX gains during the quarter.

As we've discussed with you in the past, we normally remain naturally hedged with local currency denominated debt on our balance sheet roughly equal to like currency assets. After our follow on equity offering earlier this year, we used some of the debt... some of the cash proceeds to pay down some of our Euro denominated debt associated with development properties slated for contributions to Europe fund during the second quarter. During this period, the Euro strengthened against the hedge set up for the repayment creating this FX gain. The repurchases of shares during the quarter as well higher interest income each contributed about a penny to the out performance. G&A came in at about $0.05 higher largely due to an increase in personnel or through growth of our global platforms and higher estimated bonuses are result for higher earnings.

EPS for the quarter was $0.69 per share, $0.21 above the top end of our guidance. The majority of this out performance is attributable to the reasons cited above as well as the gain on the sale of an operating property. So given the strength of our global business, we are increasing our 2007 full year FFO guidance to $3.47 to $3.52 per share. For full year 2007, operating guidance we expect same store NOI growth, which excludes lease termination fees to be 5.3% and average occupancy to be 95.2%

We are maintaining our 2007 capital deployment guidance at $2 billion consisting of $900 million for acquisitions, and $1.1 billion for development starts with approximately 60% of the development starts outside the U.S. Unwritten margin on new starts are still in the 12% to 15% range with landed market. Aggregate development profit margins for the 2007 pipe line are estimated to be approximately 30%.

Operating property dispositions will decrease to approximately $20 million. Aggregate development profits for 2007 are increased to a $1.54 to $1.59 per share. We are also increasing private capital fee income guidance by $0.01 to $0.27 to $0.28 per share. For the fourth quarter, we expect FFO per share of a $1.15 to a $1.20 with aggregate development profits accounting for $0.67 to $0.72 per share

When taking the mid point of our 2007 guidance, we expect to deliver a compound annual growth rate in FFO of nearly 15% over the last three years. When you compare the midpoint of our original guidance for 2007 of $3.30 per share to the midpoint of our revised guidance of $3.50 per share, or an increase of $0.20 there are two items I want to point out. First, our aggregate development profit guidance is up 21% from the midpoint of our original guidance, this is consistent with our gain out performance through the first three quarters of the year.

Second, G&A is higher than forecasted as discussed above due to an increase in personnel for the growth of our global platforms as well higher bonuses in line with our higher earning results. In addition, our original guidance did not include the 3% of preferred charges we incurred in the second quarter or the dilution impact from our follow-on equity offering. These costs and the charges effectively offsets the core operations out performance during the year.

For our full year EPS guidance, we are reducing it to $2.85 to $2.90 per share as a result of lowering our plant operating property dispositions. Fourth quarter EPS guidance is $0.82 to $0.87 per share. Now looking at our 2008 guidance, our full year '08 guidance is $3.85 to $4.05 per share, and here are some of the detailed assumptions, aggregate development profits of $1.87 to $2.07 per share with estimated aggregate development margins of about 24% and incentive fees of $0.15 to $0.18 per share.

Private capital fee income excluding incentive fees will be $0.32 to $ 0.34 per share. For the operating portfolio, we expect same store growth before lease termination fees of about 4% and an average occupancy of about 95%. Capital deployment is estimated to be $2.2 billion with $850 million in acquisitions, half of which will be outside the U.S. and development starts of $1.35 billion with approximately 60% outside the U.S. Finally, we expect operating dispositions of $200 million. With that, I'll turn it to Hamid.


Hamid R. Moghadam - Chairman and Chief Executive Officer

Thanks Tom, before we turn to your questions, I'd like to take a few moments to summarize the key takeaways from this call. First, the third quarter was a very strong one for us. We benefited from strong operating funding fundamentals and higher development margins, resulting from lower than expected exit cap rates.

We continued to be vigilant in looking for signs of the weakening operating environment and higher cap rates, but frankly, we haven't seen any evidence for this to date, at least not for high quality industrial assets. We'll continue in our vigilance. Our long standing investments phases continues to deliver, and we believe it will power our growth over the coming quarters and years.

We had built strong global businesses that are well positioned to withstand the impact of market cycles in individual economies. The current size of our global platform and our strategic focus make us a significant player in the markets we operate in, while allowing us plenty of room to grow into the future.

We look forward to sharing with you our progress in China and Europe, with more to come on Central and Eastern Europe and India. Our value added conversion business is kicking in and gaining attraction. We expect it to be a significant contributor to our results from this point forward. We look forward to providing you with updates on our expanding private capital business as we roll out our new Asian and Canadian funds in 2008.

Lastly, our organization is in place and I feel really good about the quality and commitment of our leadership team to the AMB mission. In short, I believe strongly that we're firing in all cylinders. We now look forward to answer your questions. Kimberly?

Question And Answer


Operator

[Operator Instructions]. Your first question comes from the line of David Fick with Stifel Nicolaus.


David Fick - Stifel Nicolaus

On state of the U.S. economy and your projections in terms of the potential for consumer recession and given that probably more than a third of the space in your portfolio is linked in someway to retail, what impact that might have?


Hamid R. Moghadam - Chairman and Chief Executive Officer

David was that you? You cut off at the beginning of your question.


David Fick - Stifel Nicolaus

Yes. I'm sorry. Did you get the whole question?


Hamid R. Moghadam - Chairman and Chief Executive Officer

Essentially, you are asking about if retail slows down... if the U.S. consumer slows down and retail slows down, would our business will be adversely effected?


David Fick - Stifel Nicolaus

It's right.


Hamid R. Moghadam - Chairman and Chief Executive Officer

I think, certainly, if retail were to slow down and the consumer were to fall out of bed so to speak, our business would certainly slow down. But I do think a pretty important driver of our business is global trade that translates ultimately in consumption and in business sector expenditures. So we are not totally dependent on the consumer, but we are for sure somewhat exposed to the consumer and that will slow us down. We don't anticipate that scenario to that extent. We do expect some slowing but not to that extreme.


David Fick - Stifel Nicolaus

Okay. Great. What will be added disclosures including your re-filings?


Thomas S. Olinger - Chief Financial Officer

Basically, in the 10-K you will see audited financial statements for one of our joint ventures and then in our first and second quarter 10-Qs you will see summary footnote disclosure regarding a couple of our joint ventures.


Operator

Your next question comes from the line of Michael Mueller with J.P. Morgan.


Michael W. Mueller - J.P. Morgan

Yes, hi. With respect to the development gains in the quarter, the upside that you were talking about in terms of margin, how much of that was driven by, let's say, the Osgood value-added conversion versus just higher volumes or timing versus expectations?


Eugene F. Reilly - President, North America for AMB Property

Michael, this is Eugene Reilly. Let me take that. We would rather not get into the business of separating out the gains. I would tell you that without the land sales on Osgood, the margins are in the low 30s versus I think 34. So there is very little impact, but I do want to make the point that if we get into backing into individual gains both for deals that have closed and more importantly prospective deals, we get into pretty significant competitive issues and that affects the VAC business substantially but hopefully that answers your question.


Thomas S. Olinger - Chief Financial Officer

Michael, this is Tom. I would add that when you look at the development gain, our performance was solely due to higher gains. It was not an acceleration of any gains in to the quarter.


Operator

Your next question comes from the line of Christopher Pike with Merrill Lynch.


Christopher Pike - Merrill Lynch

Good morning. Hamid, quick question here, in terms of public infrastructure, how important is the overall state of public infrastructure i.e. roads, bridges, utilities to your proposition in terms of growth of global trade and how did those trends in public infrastructure match up with social infrastructure in some of your newer markets and then just secondly, are there any markets, per say, where those trends are perhaps not in sync at this point?


Hamid R. Moghadam - Chairman and Chief Executive Officer

Boy, that is an excellent question and to give it the kind of answer it deserves, I think that's whole couple of hours of conversation, but let me give you some quick thoughts from the top of my head. The U.S. infrastructure is behind. Our port infrastructure and rev connection supporting it, road infrastructure supporting it is basically, we haven't invested in any of that to any meaningful degree in 20 years or so. So there are some projections that show us running out of port capacity sort of by the mid-teens. Well that's not going to happen because some of that capacity will come in but it's a mixed blessing for us. It just means that the locations that we already control are going to become more and more valuable because they are going to be scarcer and scarcer. But I suspect that this infrastructure issue will become more a topic that people will discuss in the U.S. and we just going to have to address it.

In terms of your other question about social infrastructure in emerging countries, that is a really important and big issue and China is growing like crazy at arguably double-digit rates in terms of economic growth and their social infrastructure may not be quite up to that level of sustained growth. There are certainly people who are lot more knowledgeable than that, than I will be but those will make for interesting days ahead of us. Having said all that, I think the overall big news is that there is more and more globalization and none of these constraints will get in its way. I think the only thing that can get its way are politicians who are messing with the free market and I certainly hope that won't be the case.


Operator

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


Michael Bilerman - Citigroup

Hi guys. Tom you mentioned on the development pipeline, on the $1.6 billion of developments, you have about a 23% margin and I think you mentioned that also includes the VAC and the land sales. At Analyst Day, you talked about how the value-add business really doesn't lend itself to a margin analysis. I am just wondering if you could take that $1.6 billion at least in the aggregate and split it up between your merchant development, the VAC business, and then your land sales, and just talk a little bit about the returns that you see? And then I had one other clarification question on your '08 guidance, you said $1.1 billion of development or yet a 12% to 15% margins assuming land up market. I assume your margins are going to higher on those given the fact that you have land-up book?


Hamid R. Moghadam - Chairman and Chief Executive Officer

Yes, four projects that are using land that's in a pipeline that's correct.


Thomas S. Olinger - Chief Financial Officer

Yes, maybe let add some color to that and then maybe Hamid can answer the first question. We... our land inventory, obviously is... runs anywhere from land up market to land that we carried a significant discount to market. So you are correct that as we use up our existing land inventory, we'll be seeing higher margins. New projects that we start with land at market are in that 12% to 15% range.


Hamid R. Moghadam - Chairman and Chief Executive Officer

Yes, the only thing that I would add to that answer is that we... I think outlined in our guidance for '08 that by $1.87... I think $2 and change of the total FFO would be from gains and we have already told you that $13 million to $15 million is going to be sort of our best guess today of the value added conversion business. So, just taking those two facts, you can say that may be 25% of it is kind of round numbers, 25% of it is value added conversion business.

Land gains per say are day in and day out are not going to be a major driver, may be 5% to 10%. So those would be some rough numbers but they will be a heck of lot of volatility in those numbers, certainly year-to-year and more so quarter-to-quarter. So, I would use those guidelines only as very long term estimates.


Operator

Your next question comes from the line of David Harris with Lehman Brothers.


David Harris - Lehman Brothers

Hi, I guess it's appropriate me to ask a question about London and I think you have looked at this market over some while and wanted to get in, what makes now a good time, can you tell us where the side is and also could you address how you are staffing this location?


Hamid R. Moghadam - Chairman and Chief Executive Officer

Let me make a general comment then I will turn it over to Guy for some specifics about the project. You should not view our entry into London as a market timing call on London. It's certainly one of the top five economies of the world. As you pointed out for about five or six years we have been trying to find the right entry model for coming in to the important UK market. This was a development project that enabled us to get into a very good location that will benefit, in our view from the Olympic and it just was the right project at the right time for us to get in. And you should expect us to continue to build on that early success in the UK market but there was nothing magical about the timing. It was just the right opportunity at the right time. Guy?


Guy F. Jaquier - President, Europe & Asia for AMB Property

Okay sure just a follow up on that I mean, the markets that we are going into are as we said before are really customer driven, so its really hard to have a customer driven strategy without having the UK as part of that. This particular side is in East London in an area called Beneham, North of Thames River. It is an in filled site, so given the dynamics of supply constraints around London, we found that very favorable and relative to the timing question, while we are not market timing, it's actually not a bad time to be looking at expanding into a market when we think prices might be a softening a bit


David Harris - Lehman Brothers

How would be staffing this particular transaction?


Guy F. Jaquier - President, Europe & Asia for AMB Property

We managed the transaction out of our Amsterdam office. We will be asset managing that out of Amsterdam at this time and we will look at future expansions in to the UK as is appropriate.


Operator

Your next question comes from Jamie Feldman with UBS.


Jamie Feldman - UBS

Thank you very much. Two quick housekeeping questions. On the '08 guidance what are you assuming for G&A and then for FX gains?


Thomas S. Olinger - Chief Financial Officer

Well for G&A we have seen increase of under 10% for the year and as for FX, we build our budget off of current forward rates. So we are using today's information to build our forecast.


Operator

Your next question comes from the line of John Stewart, a Private Investor.


John Stewart - Credit Suisse

With the Credit Suisse I think.


Hamid R. Moghadam - Chairman and Chief Executive Officer

The first sounds better I think.


John Stewart - Credit Suisse

Tom, can you give us a bit of color in terms of the softness in the same-store results at San Francisco and the TOMAC [ph] portfolio particularly given your comments on the Bay area. And then maybe Hamid, can you speak to margins again, I guess given the 30% that you expect to book this year done at 24% next year, do you... I guess my question is, do you expect overtime that 12% to 15% is going to be a normalized margin or do you expect to continue to build to do better than that as you begin to work on projects on land that you have held for a while?


Hamid R. Moghadam - Chairman and Chief Executive Officer

Well, let me go first as since my memory is not as good as Gene. But to the specific margin question, I think for some time we have said that the margins that are... we are seeing flow through the system right now are a result of historical land values and also declining cap rates that have occurred since we first committed to these projects, but usually what we commit to these projects are 12% to 15%.

Now all of those things don't go away immediately, in fact as you look out in our existing total pipeline we still see margins in the high teens and low 20s as some of those projects roll through. But in an equilibrium market, we believe in some of the more mature markets, the margins are going to be 12% to 15%. In some of the more emerging type of margins, they could be higher than that even on a run rate basis with fresh land at market. On top of that that's where normal developments. On top of that for value added conversion projects I think you referred to those often times not in every case, often times as multiple not margins. You should think of that as a business that in some cases at least will produce multiples of value. So when we you blend it all together in this overall measure that we are using now that could also push the average margin above that 12 to 15. So 12 to 15 is a good number for mature markets with two things that will drive that up other than cap rates falling and land values escalating or value-added conversions and some of the emerging markets. Eugene.


Eugene F. Reilly - President, North America for AMB Property

Okay. Let me address the same-store question. San Francisco was substantially dragged down by a prior year tax refund. So that is a prior year benefit that we don't have this quarter. I don't have off the top of my head what that effect could be but I think it will be closer to the numbers we saw last quarter, which I think are closer to 8%. The on tarmac business was affected by some accounting items that were one time items and again, I think our quarterly number for the on tarmac business this quarter is really not representative of rent growth we are seeing.


Hamid R. Moghadam - Chairman and Chief Executive Officer

I think qualitatively both of those lanes of business are strong and looking pretty strong looking into the future.


Eugene F. Reilly - President, North America for AMB Property

Yes.


Hamid R. Moghadam - Chairman and Chief Executive Officer

It's our take on it.


Operator

Your next question comes from the line of Michael Muller with JP Morgan.


Michael Muller - JP Morgan

Yes. Hi. Real quick with respect with the FX gain, where on the P&L is that just for clarification and then the question is with respect to the land bank, can you talk about the inventory levels for Europe and Asia and when those will likely move up?


Thomas S. Olinger - Chief Financial Officer

Sure Michael, this is Tom. So the FX impact is sitting in other income. And Guy, do you want to talk about...


Guy F. Jaquier - President, Europe & Asia for AMB Property

Yes. That is a several multiple market question. I think in Japan, you will not see the land inventory go up appreciably and that A) land is little bit more expensive there and B) it's really more of adjusting in time sort of inventory of land issue. In China, I think you'll see that net inventory start going up if not fourth quarter throughout 2008. In Europe, just to put in context a good part of early this year was us getting teams in place. I think those of you who were at the investor day, met many of them, it took a little while to get those people in place, go out searching land, I think, you will see that land inventory now coming into our portfolio again fourth quarter this year to building up in '08.


Thomas S. Olinger - Chief Financial Officer

Yes. There is a pretty healthy shadow pipeline in our European land positions, which hasn't closed or hit the books yet.


Operator

Your next question comes from the line of Sloan Bohlen with Goldman Sachs.


Sloan Bohlen - Goldman Sachs

Good afternoon. I am here with Jay as well. It is a question for Hamid on... in the U.S. given that the weakness may be potentially in the U.S. consumer, are you going to look to build more build-to-suit or are you still looking to... do expect and manage and if you can talk about the differential and yield on each of those? And then as a follow on to that, are there any markets globally you are seeing where the credit crunch has softened pricing at all?


Hamid R. Moghadam - Chairman and Chief Executive Officer

Okay. On the build-to-suit issue, to be honest with you, in a classic build-to-suit definition which is that you actually have a tenant upfront that comes and inspects the building and bids it out to five developers in the U.S. that business as much as I would like to tell we are in it, is pretty unprofitable business and unless you have a unique land position that tenants got to have, that sort of gets grinded down to a high single-digit, low double-digit type of number and we don't do a lot of that business. What happens and you have seen a couple of examples of this in our recent press releases, is that we've a major piece of land, we start to expect development projects, somewhere during the course of the development a tenant may come to us and ask for small modifications and take all our substantial portion of the building and that become sort of build-to-suit. And a lot of people actually call that a build-to-suit. Those who would have margins very similar to expect deal because maybe the rent is a little bit lower but you save a lot on carrying and demising [ph] cost. So at the end of the day, the margin ends up being pretty attractive. So the short answer to your question is we see very few of those classic, just bid them all out build-to-suit because we generally those tend to be in more commodity like locations that we don't compete in and other ones that end up looking like the build-to-suit have margins similar to respective element. The part of the question is international...


Guy F. Jaquier - President, Europe & Asia for AMB Property

Yes. I think if I remember correctly it was effective to credit crunch on cap rates and values and prices and things. I think those of us in U.S, tend to be a little bit parochial in our view and as we become a global company with now 60% of our development pipeline outside United States, as Joe introduced us to in fact that the different markets behave differently. So, while on the U.S., yes, we focused on it a lot and there has been a lot talk about our prices going to move and bid-ask spread maybe widening up a little bit. In the UK we've not really seen any impact at all not even a bid-ask spread widening. The market seems to be healthy and transactions are going on and cap rates are kind of flat. In the UK we are actually seeing some potential softening of prices; but I think that's more a factor of frankly, current debt rates being about a 175 basis points over cap rates; and reverse is true in Japan, where cap rates are about 225 to 250 basis points higher than debt rates, and we're actually this last quarter, saw cap rates come down 25 basis point in that market.

So again those of you in the U.S. have to be a little bit careful about how we view these markets when we're operating essentially a lot of our business outside.


Hamid R. Moghadam - Chairman and Chief Executive Officer

Just to clarify, I think the first part of Guy's discussion was continental Europe, I think he mistakenly said UK; so just to summarize his view as I heard it is that, Continental Europe CapEx may actually be flat to maybe even going down a little bit, UK may be softening because of the debt rates being so much higher than cap rates and you heard the answer on those.


Operator

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


Michael Bilerman - Citigroup

Thomas had a follow on the $1.6 billion pipeline, what's the amount on just the merchant development and what is the margin on that; so, if you split out the VAC and the land sales, when you talked about the 23% margin, and I assume it's lower.


Eugene F. Reilly - President, North America for AMB Property

Michael, this is Gene. We're not going to divide up the development pipeline into the component parts and get into the individual margins, we think that's a bad direction to go in for a number of reasons.


Hamid R. Moghadam - Chairman and Chief Executive Officer

Just to be really clear about that, we are all for transparency. We think it's a really good thing. But it's not really a good thing, when you're trying to get entitlements on a value added conversion project and the municipality knows exactly what you're planning on in terms of your margin. So it will not serve the interest of our shareholders if we've got into that. So, we apologize if we are appearing a little opaque on that but this is a good business reason.


Eugene F. Reilly - President, North America for AMB Property

Right and then the reason is tenant and in many cases, we are negotiating with tenants for these properties so to telegraph that is obviously pretty bad.


Operator

Your next question comes from the line of Cedrik LaChance with Green Street Advisors.


Cedrik LaChance - Green Street Advisors

Can you help me understand how you calculate the profit margin on the conversion? What I'm looking for is whether or not you're taking the profit based on the depreciated book value, a non-depreciated book value or whether or not it's based on the price at which you might have been able to sell the assets without going through the entitlement process for different property type.


Thomas S. Olinger - Chief Financial Officer

Well, it's on the original costs basis. That's how the gain is calculated.


Hamid R. Moghadam - Chairman and Chief Executive Officer

The depreciation we capture is not big.


Thomas S. Olinger - Chief Financial Officer

Exactly right.


Operator

Your next question comes from the line of David Harris with Lehman Brothers.


David Harris - Lehman Brothers

Tom, may I missed this but could you throw out your FX assumptions underpinning your '08 guidance?


Thomas S. Olinger - Chief Financial Officer

So... it's zero, we're using today's rates. So as we look out and look at forward rates that's what we're using. So we are not... so to the extent they move from today's rates that will impact us.


Hamid R. Moghadam - Chairman and Chief Executive Officer

David, we don't think we have any particular insight and direction of foreign currencies over sort of the marketplace, that's the reason.


Operator

Your next question comes from the line of Christopher Pike with Merrill Lynch.


Christopher Pike - Merrill Lynch

I guess the China development that you spoke of earlier, I don't see it coming on even through 2009. Is that just a function of you guys not expecting for that asset to stabilize until after that timeframe?


Guy F. Jaquier - President, Europe & Asia for AMB Property

Yes, this is Guy. That development start is subsequent to the end of the quarter. So where you will see that is in the land inventory, it shows up as land partial in Asia. You'll get more visibility of that at the end of the fourth quarter after we record the start and it will show up on the deliveries after that.


Operator

: Your next question comes from the line of Jamie Feldman with UBS.


Jamie Feldman - UBS

Thank you. Two quick questions, actually probably not that quick, but two questions one is, can you discuss just the opportunities set in India in terms of one kind of what your... and the extent you are comfortable talking about obviously but what the right format would be in terms of a JV or whether you would hire on the ground. Also just give us a bigger picture in terms of, is it another China, how much you think can actually get done there, obviously the things like the infrastructure is probably not as advanced what we've seen in China so far? And then an unrelated question, I think that the BAA portfolio on the market in London, to the extent that once again you are talking about it. Can you just talk about why it would or would not stay with AMB's current strategy and portfolio?


Guy F. Jaquier - President, Europe & Asia for AMB Property

This is Guy, let me answer the second one first because that's easy. Again, we don't comment on specific transactions before we... before doing transaction. Having said that, we do like London, we do like Heathrow area, they are target markets but we don't comment on specific transactions. Relative to India, we have announced we'll be doing... have 9 to 10 joint venture with local partner. We'll also be hiring or have been hiring AMB staff on the ground so we'll staff that locally. Relative to, I am sorry, the first part of that question, the opportunity in India...


Hamid R. Moghadam - Chairman and Chief Executive Officer

Sure I mean we can both talk about it. Basically, I think in the near term India will be a smaller opportunity than China because of limitations on infrastructure. We are looking at India as a very-very long-term play, in fact, I would venture out and say that India is probably over heated in the short-term in terms of all kinds of real estate. Now, there is not a whole lot of industrial taking place in India, but India... there is more capital flowing into real estate builds in India bidding up prices than you can imagine and there is not a whole lot of good land for industrial development because of the limitations of infrastructure. So, we are not looking to get-in and get-out and make a quick killing or anything. It is a slow and steady way of building a business. I think we'll do it a little quicker than China because frankly, we've gotten better entering markets than we did at the time we entered China, but in the near term it should be a somewhat smaller opportunity. In the long-term, who knows, but we are optimistic about it.


Operator

Your next question comes from the line of Mitchell Germain with Banc of Americas Securities.


Mitchell B. Germain - Banc of America Securities

Hamid, I noticed you haven't made much in the form of land acquisitions in Europe. Do you see a strategy being similar to what you just completed in the UK?


Hamid R. Moghadam - Chairman and Chief Executive Officer

I actually, I think... earlier I mentioned this, I think in terms of our shadow pipeline in the UK, which are a lot of deals that we are working on that haven't closed and please don't ask me, which ones and where, because I can't answer those, but we have a good head of steam in Europe and I think you'll see our land inventory in our strategic positions in Europe are ramping up over the next couple of quarters, if everything works the way we hope it will.


Operator

Your next question comes from the line of Sloan Bohlen with Goldman Sachs.


Sloan Bohlen - Goldman Sachs

A question for Hamid or Tom. Can you talk a little bit, this is just going back to 2008 guidance, the same-store and land growth of 4%, you'd seem just based on the strong conditions globally at your leases expiration versus current market that NOI growth should trend higher. Could you just talk about... are you expecting more broadly things to slow next year or is this just initial conservatism?


Hamid R. Moghadam - Chairman and Chief Executive Officer

Sloan, I will let Gene respond to that.


Eugene F. Reilly - President, North America for AMB Property

Okay. Sure, we are frankly surprised to the upside with rent growth this-year and we had probably built in overtime some conservative frankly related to the credit dislocation. So we have been surprised. We think in fact that third quarter was an excellent leasing quarter across the board.

In terms of the comparison to next year we are about a 100 basis point above where we expected this-year, so we have a more difficult comparison in '08. But I think '08 also reflects some conservatism which we talked about earlier on relative to what's going to happen with consumption in '08. So we don't see anything terrible happening. But there is little caution there.


Thomas S. Olinger - Chief Financial Officer

Sloan, it's a funny environment. On the one hand you got the credit crunch, and you got the consumer questions and all that we got into in this thing, at the same we get continually surprised by the good performance of our portfolio and our strategy, I'm pleased to be honest with you, we take a best shot at it. And at some parts of the cycle like today, we are going to get pleasantly surprised and I am sure there's going to be pay back time down the road at some point too. But we are really taking our best guess at it. But if the trends of the past couple of quarters continue, we should do better than what we think. But I have no... we have known that for sure.


Operator

Ladies and gentlemen, we have reached the end of the allotted time for question and answers. I would now turn the call back over for closing remarks.


Hamid R. Moghadam - Chairman and Chief Executive Officer

Great. Well, thank you everyone for participating in our call and look forward to talking to you next quarter. Bye -bye.


Operator

Ladies and gentlemen, this concludes today's conference, you may now disconnect.


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