Prologis, Inc. (PLD) Q3 2013 Earnings Report, Transcript and Summary

Tracy A. Ward - Senior Vice President of IR & Corporate Communications Hamid R. Moghadam - Chairman, Chief Executive Officer and Member of Executive Committee Thomas S. Olinger - Chief Financial Officer Eugene F. Reilly - Chief Executive Officer of the Americas Michael S. Curless - Chief Investment Officer and Chairman of Investment Committee

Brendan Maiorana - Wells Fargo Securities, LLC, Research Division Vance H. Edelson - Morgan Stanley, Research Division James C. Feldman - BofA Merrill Lynch, Research Division Gabriel Hilmoe - UBS Investment Bank, Research Division George D. Auerbach - ISI Group Inc., Research Division Craig Mailman - KeyBanc Capital Markets Inc., Research Division Michael Bilerman - Citigroup Inc, Research Division John W. Guinee - Stifel, Nicolaus & Co., Inc., Research Division Jonathan M. Petersen - MLV & Co LLC, Research Division Eric Frankel - Green Street Advisors, Inc., Research Division James W. Sullivan - Cowen and Company, LLC, Research Division Michael J. Salinsky - RBC Capital Markets, LLC, Research Division Michael W. Mueller - JP Morgan Chase & Co, Research Division David B. Rodgers - Robert W. Baird & Co. Incorporated, Research Division Ki Bin Kim - SunTrust Robinson Humphrey, Inc., Research Division

Good morning. My name is Tiffany, and I will be your conference operator today. At this time, I would like to welcome everyone to the Prologis Third Quarter Earnings Call. [Operator Instructions] Tracy Ward, Senior Vice President Investor Relations, you may begin your conference.

Thank you, Tiffany, and good morning, everyone. Welcome to our third quarter 2013 conference call. The supplemental document is available on our website at prologis.com under Investor Relations. This morning we'll hear from Hamid Moghadam, Chairman and CEO, who will comment on the company's strategy and market condition; and then from Tom Olinger, our CFO, who will cover results and guidance. Additionally, we are joined today by our executive team including Gary Anderson, Mike Curless, Nancy Hemmenway, Guy Jaquier, Ed Nekritz, Gene Reilly and Diana Scott. Before we begin our prepared remarks, I'd like to quickly state that this conference call will contain forward-looking statements under federal securities laws. These statements are based on current expectations, estimates and projections about the market and the industry in which Prologis operates, as well as management's beliefs and assumptions. Forward-looking statements are not guarantees of performance, and actual operating results may be affected by a variety of factors. For a list of those factors, please refer to our forward-looking statement notice in our 10-K or SEC filings. I'd also like to state that our third quarter results press release and supplemental do contain financial measures such as FFO, EBITDA that are non-GAAP measures, and in accordance with Reg G, we have provided a reconciliation to those measures. [Operator Instructions] Hamid, will you please begin?

Thank you, Tracy, and good morning, everyone. It's only been a month since our Investor Forum, so we'll keep today's remarks brief and focus on the company's growth objectives, real-time market conditions and results. As you know, our strategy going forward is simple. Our focus is on 3 growth drivers, which are: number one, capitalizing on rental recovery; number two, putting our land bank development expertise and customer relationships to work within value; and number three, leveraging our global scale. Let's take these one at a time starting with rent. We expect significant organic rent growth to come from the U.S. and Europe over the next 4 years. In fact, this is already materializing, as we realized the 6.1% increase in net effective rents on rollovers this quarter. The supply/demand indicators that we've been discussing for some time are coming in even stronger than we expected. U.S. net absorption for the quarter was 55 million square feet, running almost 3x the volume of completions. We're further increasing our 2013 net absorption forecast for the U.S. to 200 million square feet, up from 180 million square feet. This will be the highest level in absorption since 2006, and still significantly below the norm for expansion. This means there may still be some upside to this forecast based on what we're hearing from our customers. Space utilization in our facilities continues to trend higher, setting another record in the quarter. This means that our larger customers are short on space and unable to handle their current needs, much less their future growth. Now let's look at supply. While there's no question that supply is increasing, it's important to remember that we're starting from the basement. The financial crisis drove construction to its lowest level since World War II. We are expecting 65 million square feet of completion this year, the majority of which are build-to-suits or are pre-released. To put this in perspective, these completion rates are very low in relation to the projected net absorption for the year. This record deficit of 135 million square feet doesn't even take into account product obsolescence. As a result of this excess demand, we're forecasting the U.S. market vacancy rate to drop to 7.3% by year end, matching its prior cycle low in 2007. Pulling this all together, our sector has substantial room for growth. You may recall from our previous commentary that the recovery of investor of fundamentals has lagged the recovery of the macro economy. Occupied space rents only 1% above its 2007 level while imports are 9% higher and GDP consumption and population are all 5% to 6% higher. Turning elsewhere in the Americas. Despite a slowing overall economy in Brazil, demand for modern logistics base remain strong as the company need to serve the growing consumer market. In Mexico, the logistics market is a strengthening with growth from domestic consumption and exports to the U.S. Moving to Europe. Operating fundamentals continue to improve, and for the first time in 4 years, sentiment among our customers is trending positive. Net effective rents are growing and recovery is broadening to more markets. Rent growth combined with declining cap rates will lead to a strong recovery in European values. Demand in China is accelerating. We see new requirements from domestic retailers and e-commerce customers. Vacancy rates are extremely tight and growth rate -- and the growth in rents are quite strong with some submarkets well above 10% year-over-year. In Japan, demand has kept pace with supply but leasing velocity is beginning to exceed our expectations. With the 2020 Olympics and improving economic environment and tightening market conditions, we expect to see increases on rents in excess of forecast. As we look forward, we see several years of favorable market conditions across all our markets, pushing occupancy to levels last seen in the 90s, supporting our seasons of an extended period of rental growth. I'd now like to return to our value creation activities. The lack of supply and increasing rents continue to drive our development starts. During the quarter, we started 17 new projects, totaling $494 million globally with an estimated development margin of 19%, 2/3 of these were build-to-suit. We stabilized $500 million of development projects with an estimated margin of 38%, creating $190 million of value. We will surely grow through our value creation objectives for the year. The high-profit spread is driven by the surge in rents and low-land basis. While we don't expect to sustain this level of margins indefinitely, they will remain elevated for some time to come. The current level clearly supports the fact that the book value for our land is significantly below its fair market value. By a way of reminder, only 1 analyst is currently ascribing any value to our development platform in this any recalculation, in spite of consistent profitability of these businesses and some relevant recent comps in the marketplace. Turning to the third area of growth, we'll use our scale to expand in our existing markets and increase our profitability. We have the capacity to take on $10 billion in overall assets in our existing markets without a substantial increase in G&A. In the third quarter, we grew the platform by more than $1 billion and reduced the ratio of G&A to AUM from 70 to 68 basis points. Although this metric will bounce around between quarters, we expect to improve on with this ratio as we continue to grow our role assets. Looking to strategic capital, the third quarter marks our largest single quarter in the history of capital raising for our open and fund business. We see an important dynamic on probing. Small to mid-size investors are committing new capital and considering allocations at levels not seen since the global financial crisis. What we hear from them is that they're underallocated to investor real estate and seeking general partner will keep operating in sector experience. Looking ahead, we have a healthy investment key with strong interest evidenced by a number of investors in various stages of due diligence. To sum up, we are very optimistic about the recovery in the global investor and real estate market. We are well positioned to take advantage of the unique opportunity that legally will arise through this -- through the strength of our platform. With that, I'll turn it over to Tom.

Thanks, Hamid. This morning, I'll focus my comments on 3 areas: first, results for the quarter; second, a review of deployment and capital markets activity; and third, an update on guidance for the remainder of the year. Starting with our financial results for the third quarter, core FFO was $0.41 a share, in line with our expectations. From a core FFO run rate perspective, Q3 was up about $0.02 from Q2, excluding the promote we recognized last quarter. This higher sequential run rate was driven by the deployment of proceeds from our first half contributions and equity offering. During the quarter, we stabilized $500 million in developments with $165 million, our share value creation representing a 38% margin. We continue to see improvement in our operating portfolio metrics this quarter. Occupancy was 93.9%, up 20 basis points from the second quarter. Spaces over 250,000 square feet remain effectively sold out with occupancy at 98.2%. For spaces less than 100,000 square feet, occupancy was 90%, up 60 basis points sequentially. We saw a significant increase in average lease term for the quarter at 59 months, which was driven by leases signed for build-to-suit projects. Rent growth continues to accelerate broadly. GAAP rent changes on rollover was 6.1%, up 210 basis points sequentially, and evident across all geographic divisions and space sizes, as well as new and renewal leases. It's important to point out that our rent change calculation includes all leases signed during the quarter greater than 30 days for both new and renewal leases and regardless of how long the spaces were vacant. As we stated before, we think the most meaningful metric is net effective rent change. However, to provide you with perspective, cash rent change on rollover was a positive 0.4%, up 380 basis points sequentially. For the quarter, same-store NOI increased 1.4% on a GAAP basis and 1.8% on an adjusted cash basis. Same-store NOI will lag releasing spreads given that the NOI results we report in the third quarter primarily relate to leases signed in the first half the year. Moving to Investment Management, income was higher this quarter by almost $5 million due to growth in assets under management, primarily related to contributions to our J-REIT. On a go forward run rate basis, Investment Management income will grow in line with assets and fluctuate with these associated with fund deployment and promotes. Turning to our deployment activity in the third quarter. We had contributions and dispositions of $792 million with $361 million, our share. We invested $1.9 billion in building and land acquisitions, development starts and equity investments in our ventures with $1.5 billion, our share. Subsequent to quarter end, we acquired our venture partners of approximate 80% interest in the SGP Mexico fund. We had an opportunity to acquire these high-quality assets before the end of the investment period and are pleased to rationalize another fund. Moving onto capital markets' activity in the quarter. We continue to make significant progress in lowering our borrowing costs and extending our debt maturities, providing us with further flexibility to fund growth. In the third quarter we completed approximately $6.3 billion of capital markets transactions including debt financings, refinancings and pay downs. This included the upsizing of our 2 global lines of credit, the issuance of new senior notes and attentive. As a result of this activity, we lowered our weighted-average GAAP interest rate by about 30 bps and increased the weighted average term by nearly 6 months. Our next significant debt maturity is not occurring until October 2014, and after that, we have no material maturities until 2016. As a reminder, the weighted average GAAP interest rates shown in our supplemental for unsecured bonds and secured mortgage debt is approximately 5.1%, which compares to a coupon rate for this debt over the next 5 years of 6%. As we discussed at our investor forum, even in a rising interest rate environment, we have an opportunity to refinance or debt, extend term and continue to reduce borrowing costs in a very meaningful way. We did see a temporary increase in leverage this quarter given timing around deployment. At quarter end, our look through leverage was 37.9%, net debt to adjusted EBITDA was 7.7x and fixed charge coverage increased to 2.6x. We continue to expect to end the year with look through leverage below 35% and debt to adjusted EBITDA under 7x. Now let me turn to guidance for the remainder of 2013. For operations, our previous GAAP same-store NOI range was between 1.5% and 2.5%. As we've discussed on prior calls, we've been focusing on driving rent growth over occupancy, which temporarily impacts same-store NOI in the short term but propels it in the long-term. We expect to be at the low end of this range for the full year. We expect year-end occupancy will range between 94% and 95%. For FX, we're assuming the euro at 1.35 and the yen at 98 [ph] for the fourth quarter. On expense side, we're forecasting our net G&A to range between $228 million to $232 million. For capital deployment, we're narrowing our 2013 forecast to range between $3.8 billion to $4.1 billion. This includes development starts of $1.8 billion to $1.9 billion for the year, which implies $600 million to $700 million in the fourth quarter, with our share of approximately 75%. This range is lower at the top and versus our previous guidance as a result of timing. Building acquisitions of $800 million to $1 billion for the year with $120 million to $320 million occurring in the fourth quarter with our share of about 45% and $1.2 billion of equity investments in our funds, which we completed as of the end of the third quarter. We're not expecting to make any further significant fund investments for the rest of the year. Switching to development stabilizations. We expect to stabilize about $1.4 billion in 2013 and an estimated margin of approximately 28%, generating our share value creation of $350 million. For contributions and dispositions, we're maintaining our guidance of $8.5 billion to $10 billion. Year-to-date, we've completed $6.6 billion. This leaves $1.9 billion to $3.4 billion for the fourth quarter with our share of the proceeds at about 80%. The remaining activity relates to contributions in Europe and Japan and dispositions in the U.S. and Japan. In addition, this range also includes a couple of potential transactions that could materialize by year end. Now putting all of this together, using the midpoints of our deployment, contributions and disposition guidance, we will generate approximately $1.6 billion, our share of net proceeds in the fourth quarter. We are narrowing our full year core FFO guidance to $1.64 to $1.66 per share, which implies Q4 core FFO range between $0.41 and $0.43 a share. Before I turn it back to Hamid, I want to highlight 2 new enhancements in our supplemental this quarter. The first relates to disclosure on stabilized value creation. As we shared at the Investor Forum, transparency into our ability to create value through development is a key to understanding this important business. This disclosure will allow you to gauge our ability to consistently create value from development over the long term. The second disclosure highlights our net equity exposure by currency. Our U.S. dollar and equity at quarter end was 73% and we've continued to expect to be at approximately 82% by year end. With that, I'll turn it back to Hamid.

Thanks, Tom. Let me close by summarizing the key takeaways from our call. Absorption in the U.S. is outpacing supply and vacancy is dropping faster than we expected, supporting the case for an extended period of significant rental growth. For Europe, the rental recovery combined with what we believe to be a significant cap rate compression over the next 12 months, is expected to lead with strong recovery in values. And the combination of rental growth to profitable buildout of our land bank and improvements in efficiencies resulting from scale, set us up nicely for an extended period of robust earnings growth. Let's open up the call to your questions. Tiffany?

[Operator Instructions] Your first question comes from the line of Brendan Maiorana with Wells Fargo Securities.

I want to ask a question about the same-store, appreciate the update on the guidance, Tom. If I'm thinking about it correctly in what you guys have done year-to-date, it still implies a pretty big ramp in Q4 and given that you're focused a little more on rent growth than occupancy growth, just wondering, how you get there and can you also provide a little bit of commentary on why the operating expenses seem to be higher in '13 versus '12 and what that may do as we go into next year.

Okay, Brendan, thanks. On same-store, you're right, we think we're going to end at the low end of our range and we've been focusing on rent change, for sure, on our rents and not so much on occupancy. And we've seen occupancy be a little below where we thought it would be, hence, the low end of the guidance. But we feel very good about the trend. If you look at our GAAP same-store throughout the year, 0.3% in Q1 to 0.7% in Q2, then now 1.4%, we're on a very positive trajectory. The other thing to note, if you look at rent change, the rent change figure we report reflects signings in the quarter, and the signings are typically 3 to 6 months in advance of the effective date, so there's a natural lag between the rent change we're reporting today in Q3. And when that will actually come through our NOI is a couple of quarter lag. So you put those together, we feel good about the trajectory of our same-store growth. On the expense side, I think there's nothing systemic going on at all. On expenses, it's just timing.

Your next question comes from the line of Vance Edelson with Morgan Stanley.

A lot of skeptics out there are surprised at the continued strong absorption, just given a fairly tepid U.S. economic recovery and disappointing job growth, which ultimately should weigh on the shipment of goods. How are you feeling about the continued strength of the economic recovery based on your conversations with tenants? And also, how do you feel about your own ability to outperform?

Vance, I don't think we're outperforming, nor is the industrial market outperforming. I think there's a false impression out there that I'd like to correct, and I tried to do it in the prepared remarks. In occupied industrial space is only 1% prior to where it was in 2007. Yet imports are 9% higher, GDP consumption, every other measure, people, just population, every other measure drive industrial demand, it's 5% to 6% higher. So we still got another 4% to grow before we catch up with the other economic parameters. So we're not ahead of any economy. We're behind and hopefully, quickly catching up, but still pretty significantly behind. So I think it will last longer. Whenever the U.S. economy normalizes, I think industrial demand is going to exceed that for some period of time until it gets back into North. It's very simple.

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

This is Jaime Feldman with Jeff. So I guess with fundamentals a little bit ahead of what you guys originally thought, what does this mean for your prospects for development starts and timing to reach kind of your peak outlook for development starts?

We don't have a peak outlook for development starts. What we've said for about 3.5 years is that we expect in a normalized year, development to be about $2.5 billion. That's really a buildup of individual market opportunities as our people see them. That is not a target. We're not shooting to any given target. That's what we think it will be across the cycle. And frankly, we'll get there whenever we get there. I mean -- and we may exceed it for a period of time, we may fall short over a period of time. It's not the target. The good news is that we're making $300 million to $400 million in that business and none of that is reflected in any kind of valuation. So I guess it's not a very sensitive number.

Your next question comes from the line of Gabe Hilmoe with UBS.

Tom, on the disposition and contribution guidance, how should we think about Mexico and the Mexican REIT for that equation? I'm just trying to get a sense of the pieces to get your guidance.

Well the -- Mexico is not in our guidance at all.

I think another way of saying that is that there isn't any change in Mexico anticipated in our guidance.

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

The cash spread will spread -- clearly improved this quarter. As we look out to 2014, how do you see cash rent spreads can trend? I'm sure the spreads will improve, but any color as to how positive you think they can be?

Yes, George, as we've talked about before, we actually don't think that's an important number. And here's why. Because I think this is a really important question and we're not apartments, we have leases that are usually 5 years in duration. So take a normal situation where you have a 5-year lease with 2% escalations every year, okay? The ending rent on that lease from a cash point of view will be 10% higher than the beginning rent on that lease, just very simply. And if the market keeps going at 2%, that starting number for the new lease will be identical to the ending number for the old lease. So if we're doing our job and getting escalations in all the leases that we signed, that metric will always be 0, which is pretty disappointing. However, if we did something less optimal, we signed flat leases for 5 years and never got any rental escalations, that statistic would look great because it would say 10% change on lease expirations. So I don't understand for the life of me why that metric is important. And we don't spend any time projecting it. So I really, in all honesty can't answer your question because it doesn't really drive any value in our business.

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

Hamid, just one -- curious about your comment in the release about tenants kind of just taking space where they need now or not expansion space. Just with rents going higher and absorption continuing and good space is being taken up here, kind of what's going to drive beneath them to take a little bit of perspective space for growth in their business, just curious what tenants are saying.

So Craig, that's a really good question. A day or 2 after we had -- or actually a day or 2 before we had our Investor Forum with you guys, we actually had the top customers from around the world here in San Francisco and we were trying to get their perspective and share with them ours. I think what's going on is that companies are laser focused on margins and costs because their revenue growth has been anemic, so they try to basically produce the bottom line by being really vigilant on cost. They've been doing that for 4 or 5 years and frankly, they're out of opportunities to do that. They would like to do more of it but they can't. So anytime somebody has to make a decision, okay, do I build 1 million square foot warehouse, which is probably going to be a $70 million investment with another $100 million of inventory and improvements in it, ultimately to run my business. That's a pretty big capital investment that the CEO has to make. And if the CEO is reading the same newspapers as we are, he's going to say, "Okay, let's just try to lease a little bit more, extend our lease, can we get the adjacent space in the same building or something." But they're trying to avoid making that big CapEx decision. And by and large, I would say they were successful until about a year or 2 ago. They can't anymore. They're just drifting at the same. So the opportunity becomes losing business. I think 1.5% vacancy in buildings larger than 250,000 feet really tells you something about how tight this space is and how high the utilization rate is. I think if we get a bit of small business formation going that affects the smaller buildings, 100,000 feet and lower, I think you could see these occupancy rates go up in excess of 95%, 96% pretty quickly, because the supply side is not going to be able to catch up with us that quickly. So we think it's a pretty interesting dynamic. People are trying to defer major capital investments as much as they can, but they can't anymore. They've got to take space. And you're seeing it for some of the large players. Gene, do you have any perspective you want to add to that?

Yes, I think the only area we're seeing some kind of forward thinking is really in online retailers. So a lot of build-to-suit demand, as all of you know, is coming from that segment where it's, basically, a new business line and in some cases, it's very defensive, a lot of the bricks and mortar retailers, you're going to see a lot of build-to-suit demand from traditional bricks and mortar retailers trying to compete with Amazon and that's defensive. So in those cases, you're going to see them wanting to take more space and making capital investment. But otherwise, I mean, it's right. They've been reluctant to do so. But when your utilization rate is peaked out and the market vacancies are low, you don't really have any choices.

I'd just add that, I think a customer said that it's a little bit different geography to geography. If you think about Europe, for example, there has certainly been a return of confidence in Europe but it's still a mixed picture. But generally speaking, I think things are improving. You look at Japan, I mean, customer sentiment is very high in Japan today first because of the Abe economic policies and now because of the 2020 Olympics, so very, very positive sentiment there. And in China, sentiment hasn't changed in a while, it's just very, very strong. And in fact, again, a day or 2 ago, GDP came out, it was 7.8% [ph] as opposed to 7.7%. So again, pretty strong sentiment in Asia in general.

Your next question comes from the line of Ki Bin Kim with SunTrust. Your next question comes from the line of Michael Bilerman with Citi.

Great. Tom, I just had a question, just sort of putting all the pieces together in your guidance but also thinking about the run rate. So you had about $0.41 of core FFO in the quarter, your guidance for the year implies, let's call $0.42, $0.43, I recognized the year share count was a little bit higher than the first few quarters, but somewhere in that range of $0.42, $0.43, yet you have $1.6 billion of dispositions in terms of proceeds and I don't know what you're doing with that money, not only thinking about what's happening in the fourth quarter, but as you move forward into 2014, The Street currently is at $1.78, almost $0.45 a quarter. How do you sort of make the leap from where you are today to that point, but also even into the fourth quarter with the deleveraging that's occurring?

Well as you look forward, we will be redeploying that capital that we're generating in the fourth quarter but there will be a time lag, but you have to remember, when you look at our earnings from a run rate perspective, we're stabilizing $1.4 billion of real estate in 2013. That comes into producing NOI. We continue to have rent growth. We've seen it. The same-store is following that but it's coming. And we also have the effect of discontinued deleveraging. The impact of what we've done in the last, really, 3 quarters from an interest rate perspective now is coming through full force. So there will be a lag in redeploying that capital, probably in the first quarter of next year as we look out. But I think we'll get right back on track and we've got other drivers i.e. development stabilizations and rent growth that help offset that.

Your next question comes from line of John Guinee with Stifel. John W. Guinee - Stifel, Nicolaus & Co., Inc., Research Division: Just to focus a little bit on net asset value. It looks to me as if your FFO and AFFO numbers are based on about 504.5 million share denominator. But then when I look at Page 32, you list your common stock as 498.6 million shares, and then when I go back into the supplemental, you have the effect of some exchangeable debt. So your total share count is about 517 million shares. Can you help us sort of walk through the differences here, specifically on the correct denominator for an NAV analysis?

The correct denominator would be the smaller of the 2 numbers because what you're seeing is that the impact of, effectively, converting our convertible debt. That convertible debt that sits out there, the denominator and the larger when it's 500 million plus, assumes that, that those shares are exercised to convert that debt. So it's clearly the -- that is the main driver of the difference. And when you look at our NAV page, you should be using the 498 million, that is the right number to use for NAV.

Your next question comes from the line of Jon Petersen with MLV Company. Jonathan M. Petersen - MLV & Co LLC, Research Division: I appreciate in your disclosure around the development value creation page and supplemental. Can you help us quantify, I'm kind of curious, how much of the 38% margin this quarter is directly related to the lower land bank value? And then also, can you just kind of walk us through how you underwrite developments to get to the 19% forecast on margins for start this quarter? I'm trying to get a sense of like, how you guys think about cap rates going forward, rents, do you use today's rents or projected rents, just trying to get a sense of how conservative that is given how large margins are today.

Generally the way we underwrite development deals is that we use our market forecast for rents, the same market forecast that drive our operating assumptions and all that. So they could be flat, they could be up. In majority of cases, today they're up, and actually we've been exceeding those expectations and pretty much most of the development that we've been stabilizing. So in other words, we've been underestimating rental growth. Cap rates, by and large, we don't underwrite cap rate compression in our developments at all. In fact, I would say that in a few of them right now we have baked in some cap rate -- slight cap rate expansion. So I think the normal margins, as you've heard me say many times, I think in a normalized market when you're buying land at markets, for spec should be around 15 and for a very high credit build-to-suit should be as low as 10, so the average should be 12, 13, 14, depending on the mix. So you can think of -- forget about the 38. The 38 is just a goofy number in some unusual cases. It's real money but it's not a sustainable number. I think, yes, we've been averaging in the high teens, call it 19, and if the average is 14, should be, that means there's 5 points of excess margin and if land is 25% of the total investment, 5 points on 25% means that your land is undervalued by 20%. That's the quick math. It depends on parcel by parcel, but that would be the quick math. So I don't know, our land bank is $1.8 billion, and if you apply the 20% to it, you could argue that it's worth $350 million, more than that.

The only other comment we might want to make is that we've taken our weighted average cost of capital for every geography.

Right. So the margin is after an overhead allocation and it's also after full carry at the cost of capital of a given market, which would be, for example, higher in China and Brazil than it would be in the U.S. and Japan..

Which differs from the GAAP carrier rate that gets reported.

Yes, and it's higher.

Yes and just to finish the last part of his question, relative to the pool of the stabilizations, those 2 facilities that were driving the numbers higher by over 2/3 of the tank well [ph] was well over 20% and I'd suggest that those all had implied increase land value as well.

Your next question comes from line of Eric Frankel with Green Street Advisors.

I was just wondering, one, if you can just go over why CapEx seems to be a little bit elevated relative to historical figures? And 2, just noted that there weren't any starts from Japan this quarter, just wondering if there is any supply concerns there?

Eric, it's Gene. I'll take the capital. In a couple of calls ago, we talked about this. If we look at a CapEx overall, that trailing fourth quarter number is ticking up a little bit. But remember, that takes into consideration lease expenses and turnover costs, which tend to be volatile, and those are going to be going up on a dollar basis because we're signing longer leases and higher rents, and that's going to trigger higher commissions, and probably slightly higher TI. But the best way to take a look at that is on Page 15 of the supplemental, where we talked about turnover costs as a percentage of the value of the lease because that's the right metric to think about. We're investing this capital to get in return, a lease, and that's actually declining quarter-over-quarter. I think that's probably going to stay at the sort of low 7s. But in terms of overall capital, as I said, we were ticking along at 12% through the last year or so, that's up to 14%, 15%, close to 15% right now. That will settle out 13% to 14% in the long-term. And it may take a quarter or 2 to get there, the reason for that is, we're -- through our dispositions and repositioning program, we're reducing the age of this portfolio, increasing the quality. And that has a significant effect on our normal capital that we spend, roofs and parking lots. So it's elevated this quarter but over the long-term, you're going to see that come down to 13%, 14%.

And Eric, with respect to Japan, we started 2 buildings in Japan, couple $100 million. We said, generally speaking, that we would expect to start somewhere in the range of $400 million to $500 million per year and that's still our general view. I am not at all concerned about demand and supply in Japan. They're still well-balanced. The new deliveries that are coming to market are basically ending up being pre-leased as they come to market. And you will see a slight uptick in 2014 in terms of vacancy rates, they're going to move from call it 1% to 2%, to call it 4% or 5%, but that's still very, very low. So we're pretty comfortable with Japan.

Your next question comes from the line of Jim Sullivan with Cowen.

Can you share with us the cap rate on the buyout of your partner in Mexican fund?

Jim, we can't for confidentiality reasons. But you're a smart enough guy, you can figure it out.

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

Can you discuss -- give a little bit of color on leasing trends in Europe for the quarter there? And then also just give any amount of influence you've seen into the investment management business there? Rich, specifically, for European funds, can you just give us a sense of what kind of the return expectations are, for the [indiscernible] coming in?

Well in terms of leasing activity, I think leasing has been pretty consistent in Europe. I actually feel good about where our occupancy levels are today. We've maintained 93% occupancy levels throughout the year and that percentage is actually going to increase, I think by year end. If you really dig into it though to see what's happening in Europe, you really have to take a deeper look at each one of the countries. We're operating in 14 different countries there. Only 3 of those countries are below 90% occupancy levels today. So in those markets we're solving for occupancy, and those markets are the markets that we've talked about before: Spain, Italy and Hungary. Spain, for example, has increased in occupancy, 700 basis points over the course of the last year. And in the other markets like the U.K., Germany, Sweden, Slovakia, some of the stronger markets where you see occupancies at 97%, 98% 99%, we're pushing rents. So again, I think that the leasing trend is positive and the rent growth trends, generally speaking in Europe, is positive as well. In terms of new investor activity, there's been a ton of investor interest in our funds. We've seen that manifest itself over the course of the quarter in terms of new investment. Return expectations, I think, would probably be in the -- for core, in the 8% to 9% range.

On leverage.

On leverage, sorry.

Your next question comes from line of Michael Mueller with JPMorgan. Michael W. Mueller - JP Morgan Chase & Co, Research Division: It looks like the Japan sequential occupancy dipped from Q2. Was that a mix issue or is that something else in there driving it down?

A single building issue. We had a 620,000 square foot building come vacant in Sentrar [ph]. It was a consolidation play, nothing to be concerned about. I'm happy with that building coming back. We'll get it leased up and that will look great again shortly.

Your next question comes from the line of Dave Rodgers with Baird. David B. Rodgers - Robert W. Baird & Co. Incorporated, Research Division: Follow-up on some of the smallest space leasing trends maybe since May or April of earlier this year, I guess one would be a clarification question, do you include your development leases in the average length and the TIs that you quote? Maybe Tony can give us some color on that, and then I think the second part of that is really, you got a higher margin length of deals you're signing, you're singing larger deals as you said, does that imply that you're seeing more challenges on leasing up the smaller space? And can you give us some more color about the small space leasing, particularly in the last 6 months?

Dave, our leasing activity and the average trend does also include our development leasing.

And David, it's Gene, I'll take the second part of the question, and I think Gary will provide some color, too. What we've really banked on in the small space leasing, in the U.S., we had a 90 basis points over the quarter, by the way, in sub 100,000 square foot units. We've been banking on the housing recovery, that's been a pretty good recovery, until the last couple of months where, if you look at the headline numbers, the broad macroeconomic numbers, that's flat total a little bit, but I think that's a normal reaction to interest rates frankly spiking during the spring and early summer. And we think this is going to resume and our customer activity tells us that, that you'll see a continual increase in home building activity. So we are, I'm going to be really clear on this one, we're really bullish about small space leasing, and it's really broad based. All of our markets in the Americas right now are active in terms of small spaces. So we don't have any laggers anymore. Places like Chicago and Atlanta, which have been really slow to recover and particularly in that segment are active. And we push rents 6% over the quarter in that segment. And finally, we'll see, obviously small business job formation is going to be the future for that segment of our portfolio. We'll see how that plays out over the next couple of years. And one thing to remember, the discount to replacement cost rents in that segment is more significant than any other. There's 0 construction virtually in that segment and as it does recover, that's our best chance to push rents in the portfolio. So we're bullish at this point and the activity right now is pretty good, despite what you see in the headlines.

And just, with respect to the average lease term, it did go from 49 to 59 this quarter, it is driven really by the build-to-suit leasing. If you look at the operating portfolio leases, they were about 45 months, the development leases were really 140 months, skewed somewhat by a large deal that we did in the U.K. with Sainsbury a build-to-suit that was a million square feet and 25-year lease. So I think again it's underscoring that there's really limited opportunities in the greater than 250,000 square foot category and customers are having to go to build-to-suits, big buildings, long-term leases and they happen to pay replacement cost rents, which again, I think, sort of underscores our rental growth projections.

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

Just to follow-up, it's Jamie again. Can you talk about cap rates and just what's happened maybe over the quarter across your markets, whether they're up or down or flat?

Yes. This is Mike Curless. Frankly, we thought we'd see broad stabilization of cap rates and we saw yet again a little bit of compression, particularly in the coastal markets, LA, you're seeing 5 and tick below, similar numbers in Bay Area and the East Coast, middle of the country, squarely in the 5s and 6s and where we saw the most compression continues to be in the B product in the global market, as well as some select regional markets, that markets like Las Vegas, Indianapolis, seeing some pretty impressive numbers in terms of their cap rate compression. We do expect over time this to level out and that sees much compression going forward. But in general positive news in the quarter. In Europe, we're seeing U.K. breaking the 6 barrier into the 5s, Central and Eastern Europe in the 7s and everywhere else somewhere in between. I think as Gary mentioned before, we got a good 100 points of room if not more in that part of the world and seeing good results in Asia and Brazil as well.

Jim, just to add, in China and Japan over the quarter, we saw, call it 10 basis points, something like that. But I was in Europe for Expo Real, which is the big trade fair there. And we met with vendors, investors, bankers, competitors, and I can only tell you that my prior view was reinforced. We are absolutely at their inflection point, I'm certain of that, and values which really haven't moved in 4.5 years and they dropped, call it 25%, 26% from peak, are about to move up. And it's going to be a combination of 2 things: rental growth and cap rate compression. And I think it's going to move faster than people realize.

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

I just want to follow-up on land. I think there were $25 million or $27 million of land sales in the quarter. I know we've spoken a lot about what the value, the current market value of the land bank, maybe relative to the development margins that you're getting. Just wondering if there were gains on those sales and what the magnitude of the gains may have been? If any.

Brendan, this is Tom. The gains on land, that we did have gains, it was pretty, it was nominal.

Yes. Remember what we're selling, we're selling the stuff that we don't want to develop. As you know, we've categorized our land into a number of different buckets depending on the timeframe for monetization and also strategic fit. And by and large, we're still -- not by and large, we're exclusively selling things that are not a strategic fit for our business. So those would be the ones that you would expect the lowest spreads of fund. And frankly, as we're getting ready to sell them, they've been scrapped on mark-to-markets so by definition, they're held for sale and there should be nothing on those anyway.

Your next question comes from the line of Ki Bin Kim with SunTrust.

Just a couple of follow-up questions regarding your -- the fund-raising activities. First, you raised your equity stake in a couple of your European funds. So my first question is, what is the appraised cap rate you're buying these funds at? Or buying these fund at versus an improving market in Europe and where you think spot rates could go, maybe 6 months forward, with maybe half a year, better data points in Europe? And second, with equity, third party equity rates, your rates, are just a substantial amount of dry powder. For your capital deployment activity, how should we think about this going forward? And how much of this will you use to sell on balance sheet assets to your funds versus third party acquisitions?

So generally in Europe, the cap rates in our funds are in the mid-7s and that's where we've been deploying capital. And as you heard a few minutes ago, our view -- we don't have a 6 months view. We're not that smart, but we think in a couple of years, cap rates in Europe can be, for this still same asset, can be in the mid-6s anyway. So 100 points to 125 basis points of decline. That would put them in their traditional historical relationship to U.S. cap rates and global cap rates. So we do think the opportunity in Europe is pretty unique that way. I would say we are pretty much done with buying up in our funds. I'm not going to say that we won't ever do any more of it, in the near-term we might, but I think we're substantially done with that program of investing in our funds. And I don't remember the back half of your question.

[indiscernible] acquisitions.

What are you going to do with the dry powder.

We're going to buy on balance sheet...

Oh, yes. So we have -- remember, the contributions from the balance sheet assets were essentially deferred for 3 or 4 years. So there were a bunch of parks that had buildings built on them that were sitting on the balance sheet that normally belong to the funds because the funds we are dealing is the balance of those assets. So many of the acquisitions that will take place in the funds for which we raise capital will come from the balance sheet as part of our contribution program or sale program to those funds because those will have to go there to complete the parks and create integrated ownership of parks. On a steady-state basis, we will not have these assets pile up on the balance sheet by and large, because you will have a normal recycling of assets into the fund. Our strategy overseas is to own everything within funds. So by definition, the balance sheet assets that are development will end up in funds on probably a more continuous regular basis.

Kim, just to reiterate, so by the end of Q4, we think most of those balance sheet assets, as Hamid said, will be contributed. The funds have all the equity raised and it's a matter of just assets coming off the pipeline as they stabilize.

Yes and we continue to buy third party assets too, and at a significant clip. But I think the numbers for the balance of this year will be overwhelmingly balance sheet contributions and beyond this year, I think it will be a more balanced mix.

Your next question comes from the line of John Guinee with Stifel. John W. Guinee - Stifel, Nicolaus & Co., Inc., Research Division: Just following up on one of the prior questions, Hamid. You were quoting 7.5 cap rates in Europe dropping down to 6.5. How does that correspond on a per pound basis, is the 7.5 cap 80% of replacement costs or 120% of replacement costs, typically?

Well it's 80% of replacement costs. I mean that's why you're not getting any construction, certainly you're not getting any spec construction in Europe and few build-to-suits because you can go lease existing space for a big discount. So I think rents have to move quite a bit before you'll see them exceed replacement costs and therefore be a catalyst for development.

[Operator Instructions] Your next question comes from the line of Michael Bilerman with Citi.

We should probably move on. Probably Michael dropped off.

[Operator Instructions] Your next question comes from line of Jim Sullivan with Cowen.

Just a follow-up question on some of these leasing metrics, and I don't want to make too much of these numbers. But looking at them, the retention ratio has declined here in the third quarter versus what it was over the prior several quarters although admittedly, it is just a little bit higher than it was in Q1. And at the same time, of course, spreads have been widening. And I guess, the general question is, are you getting push back from customers as you try and push rents? Understood there's not a lot of spec construction or spec development available, but to what extent, given uncertainties, given concerns about growth on the part of tenants, are you just seeing a real reluctance to accept any sort of increases?

Jim, we get push back from tenants even when we try to drop rent. But 80% retention is pretty good. If anything, I'd give the guys a little bit of grief over that. I think that's almost too high. If we are in the business of pushing rents, I think that number should be more like low 70s. So I'm not at all concerned by that number. But Gene, do you want to add any color?

No. It's kind of interesting. And the same is true for -- we had some markets, Jim, that are, some submarkets that are 99% leased.

Right.

And I think, maybe you and I have actually talked about this, that's a bit too high. Frankly, you're not pushing rents high enough if that's the case. I mean, getting to your fundamental question on resistance. Of course, our customers see these spaces as a cost set [ph] , that's always been a focus with markets and that. But I'll tell you, it's also a part of their supply chain and they're trying to ring on efficiencies in the supply chain and save dollars overall. So ultimately, they need spaces there in good locations that affect their transportation costs and modern spaces that they can utilize with high levels of efficiency. So with respect to modern space, sure, there's pushback. But as you can see in the numbers, we've been pretty successful in pushing rents. For Class-B and Class-C space, you have to ask other guys for that. But so far, so good.

I will now turn the conference back over to our presenters.

Can we have a couple more questions? Is Michael Bilerman on the queue still?

Michael Bilerman with Citi, your line is open.

So just 2 quick follow-ups. One was just on the sales in the fourth quarter, so the $1.9 billion to $3.4 billion, it's a pretty wide range, we're a month into the quarter. So maybe you can sort of just breakdown, you talked about European contributions, Japan contributions, U.S. sales and Japan sales, and then some other things that could materialize, sort of what are the buckets? What is sort of in place? And what would happen? And the second question was just in terms of rent. And I guess we've gone back and forth about what to look at. What we do know is on Page 17, your rents that are expiring at about 515 a foot, globally your share. What is the current rent per foot that you're signing today and where do you think that could go next year so we can think about the marketplace of rents, both in place and then some market growth, to know where that spread goes?

Michael, our range is by the way, a lot smaller than it was last year before we did the Norges transaction and the J-REIT as you guys kept asking us about on this call last year. So we're improving, huh? Tightening our range?

Michael, so color on, so if you look at the midpoint for dispositions and contributions, it’s about $2.2 billion. And that would, the mix of that would be contributions primarily in Europe and Brazil and Japan. We already completed some, in Japan already in October, that's about $1.5 billion. And then you have sales predominantly in the U.S. and a little bit in Japan, that is about $700 million, that's $2.2 billion gets you right to the midpoint. Like I said in my prepared remarks, there's a couple of other things that could transpire we're working on. But that's a matter, I believe of timing, in whether -- but at the midpoint, things are, I feel very, very confident about our midpoint. Your second question on rents.

Second question was asking for guidance for Europe, which we're not providing at the moment.

But we did say in the last quarter's call, the mark-to-market rents were basically 5 to 10 and I think that's probably pretty consistent today.

If anything, it's a little wider, I would say.

Your next question comes from the line of Ki Bin Kim with SunTrust.

A quick one. You guys quote stabilized yield or margins on development starts and a stabilization is now. I remember, several years ago, you guys used to quoted add contribution when you actually sold the assets to the funds. So my question is, how do those projected margins and cap rates compare to when you actually sell in to the fund?

Well, first of all, our strategy's changed dramatically from a few years ago. I think a few years ago, there was so much focus on contributions to the funds and quarterly earnings and that was in the FFO number and it created a lot of, I think, unnatural behavior. I think our business strategy right now, is that development is a source of creating value and whether we realize that value through contributions or third party sales, or frankly, keep the assets in our portfolio and enjoy a higher return over time. Those are all equivalents. So what we'd rather talk about is value creation as opposed to value realization. But your question is a good one, how does value realization compared with value creation? And I would say, so far in the cycle, it's exceeded it pretty substantially. And that's why we are now showing you both what the realizations are and what the actual creations are. But our own focus is on value creation, not realization. The act of actually selling it, it's kind of like looking at a portfolio manager who has a bunch of stocks and saying, "Well, did you sell IBM at the end of the quarter?" That's the only way you get to account for your results. No, there's a market value for it and it's very important part of our business and frankly, we're disappointed that we're not getting valuation for that over $300 million a year kind of engine that we showed the track record to everyone about a month ago. So hopefully, over the cycle, that will become more of a real value in the eyes of most people.

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

Just one of the focuses of the investor day was working down the land banks there. Just giving the budgeting process right now, as we look ahead to '14, what's kind of -- what do you think that realistically can be monetized there? And as you're putting it in the budget, how much land you think you're going to need to, for '14 at this point to start adding to restart the pipeline?

This is Mike, and we've said on a couple of calls, our IDSI is a land bank would support a run rate of $2 billion to $2.5 billion worth of development and lands 25%, that would translate to roughly $1.5 billion, $1.6 billion in total land size. We're working our way towards that in the last year, we put off almost a couple $100 million. And not only have we gotten total size now, but we also reconstituted the quality of the land bank and I think that will pay off significantly as we continue to monetize those sites. So I think we're headed in the right direction and at the end of the day, $1.5 billion to $1.6 billion remains our ideal target.

Okay. You'd mentioned, I think there's a $400 million number of non-core of land. Is there any chance of expediting that or is that just kind of going to be work through the process at this point?

We'll continue to work through that. Our nonstrategic land this year, we've already sold $100 million of that, and we have an activity to continue to reduce that. So over time, that would be a smaller, much smaller part of our land bank.

Since that was the last question, I wanted to thank you for participating in our call this quarter and look forward to seeing you in the new year [indiscernible] and then in the new year on the next call. Thank you.

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