Prologis, Inc. (PLD) Q1 2017 Earnings Report, Transcript and Summary

Good morning. My name is Kim, and I'll be your conference operator today. At this time, I would like to welcome everyone to the First Quarter 2017 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Tracy Ward, you may begin your conference.

Thanks Kim, and good morning, everyone. Welcome to our first quarter 2017 conference call. The supplemental document is available on our website at prologis.com under Investor Relations. This morning, we'll hear from Tom Olinger, our CFO, who will cover results and guidance and Hamid Moghadam, our Chairman and CEO, who will comment on the company's strategy and outlook. Also, joining us for today's call are Gary Anderson, Mike Curless, Ed Nekritz, Gene Reilly, and Diana Scott. Before we begin our prepared remarks, I'd like to state that this conference call will contain forward-looking statements under federal securities laws. These statements are based on current expectations, estimates and projections about the market and the industry in which Prologis operates as well as management's beliefs and assumptions. Forward-looking statements are not guarantees of performance and actual operating results may be affected by a variety of factors. For a list of those factors, please refer to the forward-looking statement notice in our 10-K or SEC filings. Additionally, our first quarter results press release and supplemental do contain financial measures such as FFO and EBITDA that are non-GAAP measures and in accordance with Reg G, we have provided a reconciliation to those measures. With that, I'll turn the call over to Tom, and we'll get started.

Thanks, Tracy. Good morning and thanks for joining our first quarter earnings call. I'll cover the highlight for the quarter, provide updated 2017 guidance and then I'll turn the call over to Hamid. We had a strong start to the year with core FFO of $0.63 per share, which exceeded our expectations by little over $0.02. The outperformance from all areas of our business with $0.01 from operations, a little less than $0.01 from deployment and the remainder from strategic capital. Asset quality and location have never been more important as supply chains extend closer to major population centers. Our portfolio is well-positioned to take advantage of this secular shift toward the end consumer. We leased over 39 million square feet during the quarter, down from last year as we were effectively running out of space to lease. Global occupancy at the end of the quarter was 96.6%, an increase of 50 basis points year-over-year. Notably, occupancy in Europe increased 180 basis points over the same period to 96.7%. Our share net effective rent change on rollover was a very healthy at 19.6%. U.S. was 29.2% an all-time high in the fifth straight quarter above 20%. Our share net effective same-store NOI growth was 5.8% for the quarter, driven by higher releasing spreads and a pick up in average occupancy. U.S. led the way with same-store NOI growth of 7.1%. Our same-store pool does include development completion that are available for lease. Excluding these development assets, our same-store would have been 5.1% on a global basis for the quarter. Moving to capital deployment, we had an active first quarter. Margins on stabilizations and starts remain very good and build-to-suits were 77% of our first quarter starts. Dispositions and contributions are on track. Fire activity remained strong and market cap rates depressing slightly. As a result, we're accelerating disposition timing. We completed several transactions in our co-investment ventures during the first quarter, further streamlining our business. We sold our investment in European logistics venture generating $84 million in proceeds. Simultaneously we combine those $600 million venture into our targeted European logistics bond resulting in a vehicle with $3.2 billion in assets. In the U.K., we formed a new $1.3 billion development to hold venture, generating $213 million in proceeds. In the U.S., we acquired our partner's remaining equity interest in our North American Industrial Fund or NAIF for $710 million and currently own a 100% of this $3 billion vehicle. Finally, we acquired an additional 25% interest in our Brazilian platform for $80 million and currently own 50%. We expect to recapitalize our ownership in NAIF over time, providing us with about $1.8 billion of future incremental liquidity. All of this activity is consistent with our plan to rationalize our funds into fewer differentiated vehicles. We now have 10 funds down from 20 in 2012. During this same period, we significantly increased our third party AUM and corresponding revenues and now over 90% of our fees from -- 90% of our fees from these vehicles are perpetual life. Turning to capital markets, during the quarter we completed two-yen financing, underscoring our ability to access the global capital markets at very attractive levels. This included recasting our ¥50 billion revolver at a 40-basis point spread over yen LIBOR and we completed a ¥12 billion unsecured loan at a fixed rate of 95 basis points and a term of over 10 years. Our leverage increased to 36.7% on a book basis at quarter end as a result of deployment timing. However, we expect to work this back down below 35% by year-end. We ended the quarter with $3.8 billion in liquidity and remain well positioned to self-fund our future deployment. Moving to guidance for 2017, I'll cover the significant updates on our share basis. So, for complete detail, refer to Page 5 of our supplemental. We're increasing our forecast for year-end occupancy to range between 96% to 97%. We're also increasing and narrowing the range for same-store NOI growth to between 4.5% and 5.25%. The impacted development completions on our same-store pool is less than 50 basis points for the full year. Our in-place leases continue to be 12% under rented globally and this will be a significant driver of NOI growth forward. Cash same-store NOI growth should be higher than net effective by over 100 basis points for the year as the lag from longer lease terms and steeper rent bumps begins to close. There is no change to our 2017 deployment guidance; however, you should note that the acquisition of the remaining equity interest in NAIF is not included in these amounts. For strategic capital, we now expect net promote income for 2017 to range between $0.12 and $0.14 per share. The increase of $0.06 at the midpoint is due to rising property values from higher-than-expected rents and slight cap rate compression. I want to remind everyone that there will be a mismatch between the timing of promote revenue and its related expenses. As a result, in the second quarter, you will see a net promote of $0.13 to $0.15 per share with the remaining expenses recognized over the balance of the year. Our 2017 estimated core FFO was fully hedged relative to the U.S. dollar and we've already hedged most of 2018 and almost half of 2019. We also remain well insulated from foreign currency movements impacting NAV as we ended the quarter with over 93% of our net equity in U.S. dollars. With the strength and operations, higher promote and higher deployment, we're increasing and narrowing our 2017 core FFO range by $0.10 at the midpoint to between $2.72 and $2.78 per share. The components of the raise are driven by $0.06 from promote, $0.04 from operations, $0.01 to $0.02 from net deployment timing offset primarily by slower development leasing in Brazil. Our revised guidance represents a year-over-year increase of 7% at the midpoint or 8% higher excluding promotes. The success of our strategy of having the highest quality assets and into locations is evident in both our financial and operating results. 2017 is off to a great start and we remain focused on continuing to drive growth while further simplifying our business. With that, I'll turn it over to Hamid.

Good morning, everyone. As you just heard from Tom, we had another great quarter. The strategies we put in place years ago, combined with strong market fundamentals and relentless exclusion by our team will lead to continued good performance in the foreseeable future. In my commentary, I'll touch on some nuances on the margin, but the basic message is that our business is strong and absent an external shock, we expect it to remain that way for quite some time. Looking at the current market dynamics, following a period of accelerating demand last year, the U.S. industrial market levelled off to a more sustainable pace in the first quarter. Demand was broader than just eCommerce and was driven by other sectors such as housing and transportation. This picture would have been even stronger but for several retailer bankruptcies. Turning to supply, I would like to flag a few markets where we see some risk. In the U.S., strong demand and sub 5% vacancies seem to have encouraged elevated levels of spec development in some regional markets like Indianapolis and Louisville as well as larger markets like Dallas, Houston, Atlanta and Southern California's Inland Empire. Public REITs have remained disciplined, accounting for just 16% of spec start in the first quarter. By contrast the handful of merchant developers, backed by institutional capital are fueling this wave of development. After seven years of demand outpacing supply, we still expect to reach equilibrium in 2017, but given the number of new starts underway this year, we now expect supply to slightly outpace demand in 2018. Nevertheless, it's key to remember that a market in equilibrium at 5% vacancy still translates into pricing power for quality properties in the right locations. For us Europe continues to benefit from the favorable supply-demand balance and record low vacancies, especially in the U.K., Germany and the Netherlands. We expect Europe to boost our growth starting in 2018. Development in Europe remain disciplined in the first quarter and in our case, 100% of our starts in the region were build-a-suits. The exception to discipline in Europe remains Poland what its low barriers to development and builders who continue to lower investors with artificially inflated headline rents. Recently I fielded many questions about the potential of -- potential relocation of manufacturing activities and its impact on our business. I'd like to remind everyone that starting more than a decade ago, we began to realign our portfolio towards major population centers to take advantage of the consumption power in these regions. With very few exceptions such as the border market in Mexico and a tiny piece of our business in China, our holdings are oriented towards the consumption, not the production end of the supply chain. As a result, our logistic real estate is increasingly the last touch on goods before they reach the customer. While we're monitoring policy developments around the world on tax and trade, we remain as convinced as ever that our focus on high barrier markets where land is scarce and new development is expensive and where more than 85% of our portfolio is located will help us deliver strong relative performance over time. To conclude, we continue to have a positive outlook for 2017. Our strategy to own top-quality logistics real estate in sought after locations near consumers has never been more relevant. Over the next few quarters, we'll continue to show how quality and location can create a strong foundation for sustainable earnings growth in the years ahead. With that, I'll turn it over to Kim for your questions. Kim? Operator? Can the participants hear us? Is there a way somebody can send one of us an email or something? I don't know what happened to the operator.

[Operator instructions] Your first question comes from the line of Rob Simone. Your line is open.

Hey guys. Good morning. Thanks a lot for taking the question. Hamid, did I hear you right that you expect supply to outpace demand next year?

Yeah best guess, I think demand will be in the low 200 million feet in the U.S. and supply, which is not a lot of guesswork by the way. You kind of know what supply is going to be out in 12 months and the 14 months. I think supply is going to be like 230 million to 245 million. So maybe…

Oh! Sorry, I was going to ask do you guys have a view for kind of what that may mean for the pricing environment and your roll up?

Nothing. In terms of our forecast, we were pretty much counting on supply exceeding demand in their sub 5% vacancy market in 2018, 2019 timeframe and we're not really saying anything new. We just don't want anybody to be surprised when supply finally responds to demand. And the issue is I would say focused on maybe five or six market and if a few players.

Okay. Great. Thanks. I'll queue up again.

Your next question comes from the line of Sumit Sharma. Your line is open.

Sumit Sharma, but that's okay. All right.

I think it was worst.

I've heard it, yeah. So, it's okay. All right so Sharma is on. Okay. So, we've been -- we've been tracking some of the demand for logistics assets in Europe and I guess across the world and have recently noticed more discussions on last mile delivery, particularly as it works in the Continent. I think Amazon was out over the week -- in the headlines over the weekend with some 1300 last mile warehouses needed in Continent I guess. So just wanted to get a sense of how your portfolio, specifically the European portfolio is positioned in terms of last mile versus let's say bulk? And second, I guess how does the CBRE co-venture equal into this equation as it applies to the U.K. side of things?

Okay. That was two questions but since they -- they destroyed your name, we're going to let you go away with it. So, let me start with the last one first. The U.K. joint venture is purely the reason for it is that the capacity of our existing funds to absorb completed product is limited and our U.K. development machine can produce some very good assets at very good margin. So, we needed a home for our excess development volume in the U.K. and that was the purpose of forming this center. So, it's very, very simple. With respect to the last mile industrial real estate, let me give you the cynical view and my view because there are two views out there. The cynical view is that everybody is calling. They're not so great real estate, that old obsolete, poorly located last mile and putting some shine on it to get better cap rate execution on sale. I can assure you that's not what we're doing. We are very deliberately going after the last mile opportunity by actually investing in infill sites in major metro areas around the world, but specifically in the U.S. and Europe and to redevelop and densify assets to do multistory buildings in these land-constraint locations. In fact, we had our ground breaking on our first property of this type in the U.S. last week in Seattle and you can expect us to have further announcements of these kinds of properties. And if you remember, we basically had two company strategies coming together. Before the merger AMB was very much and more of an infill large market player. Prologis was much more of a bulk player. We have now rationalized those two portfolios coming together by reducing everything down to the global market, but there is still a very large component of near infill last mile last, last five miles whatever you want to call it. The name is not important, but infill real estate in major -- metro areas, which were predominantly the old AMB assets. now AMB's presence in Europe was lower than Prologis and so I would say the mix of those opportunities are greater for us in the U.S. then in Europe, but we are just as deliberate about those opportunities in Europe and you can see us getting after that opportunity in a major way with some initiatives that we have ongoing right now.

Your next question comes from the line of Blaine Heck. Your line is open.

Thanks. Good morning out there. Just wanted to talk a little bit about the uptick and same-store NOI guidance. I guess it was a little surprising given that you saw same-store expenses tick up a little higher this quarter than they've been running. Maybe for Tom, can you talk about whether the increase in expenses was expected and what's driving that increase?

Yeah, the increase in expenses is primarily due to just higher real estate taxes. You see the offset in revenues as well. So, they're recoverable. It had about a 30-basis point impact on revenues. So quite small actually. So, same-store revenue growth was still over 4% with OpEx. So, nothing to look into the expenses. It's really a matter of little bit of timing and mostly the real estate taxes, but don't expect that to be a trend this year.

Your next question comes from the line of Jamie Feldman. Your line is open.

Great. Thank you. Hamid, you had commented on retailer bankruptcies maybe dragging on some of the demand in the quarter you're seeing across the markets maybe specific markets and maybe what your expectations are going forward?

Yeah Jamie, I don't know if I have any unique insights on retailer bankruptcy, but let me give you this because there are fixed in our portfolio. We monitor credit loss pretty carefully and we underwrite every tenant's credit in every industry sector. In our typical pro formas, we assume about a 0.5% credit loss. We're running at 20 basis points. So, we're significantly below trend and for those of you who have been around long enough as you have, in the global financial crisis we got up to the low 1% range in terms of credit loss. So, if you pinpointed to what some people refer to as troubled retailers, our exposure to those guys is less than 0.5% or 1% of the portfolio and frankly in a lot of those instances we would rather gave up the space than they’ve in the space. So, I don't -- that's not on my first three pages of issues I worry about.

Your next question comes from the line of Nick Yulico. Your line is open.

Thanks. Can you just quantify a little bit more the impact of consolidating NAIF and also what was the benefit to full year FFO and then from a yield basis, it looks like it might be -- you gave some of the pro forma NOI adjustments. It looks, it's not clear if that was for a full quarter or not, but looks like you bought it around six-type yield, is that correct?

This is Tom. I'll take that. So, first of all from the impact of the earnings on the year, you've got to look at deployment in total. So, as I said in my prepared remarks, we see deployment higher by $0.01 to $0.02 for the full year. Clearly, NAIF is part of driving that increase. However, we've also talked about, I also mentioned that we're accelerating sales as well. So, from a timing perspective those are offsetting to about $0.01 to $0.02 a share. The impact for the quarter in our EBITDA that we show in the supplemental, we do pro forma for a full quarter impact of that. So, you are seeing the full quarter impact of the NAIF transaction in our stock.

Yeah and the real cap rate the way we count it was midsize, but given that the portfolio was pretty well occupied, the actual cash yield was higher than that.

Your next question comes from the line of Tom Lesnick. Your line is open.

Hey, good morning out there on the West Coast. Hamid, I appreciate your comments earlier about the shifts in supply and demand and calling out a few markets there. I guess bigger picture with the potential repeal and/or replace Dodd Frank and the relaxation of lending standards, do you think that the investor base this time around will remain more self-disciplined or do you think that the banking system will really have to be the governor once again?

Well I think Basel III is actually the bigger governor than Dodd Frank. So, they need to obviously count based on risk based capital rules and that just makes the business less profitable than it was before given the reserve requirements and they need to retain. So, I think there's that general backdrop anyway. As to people's discipline, I don't know. Memories are not very long in this business, but I think the business has really, really changed in other ways than just the banking system. I think land is much more difficult to come by. The cities are getting much, much tougher on land and those are tougher and more expensive. So, the average cost and size of the industrial building is going up. So, the barrier for entry of smaller players is now higher. There is a ton of information. You get on this call and there are 200 people on this call right. So, all of them just heard me say that I think supply is going to be a different picture in the first quarter next year and there are some people that are potentially getting a little bit over their skis. Well guess what, that word will get around pretty quickly. Now I don't want to give too much credit to Prologis and our role in this call, but I think there is just so much information around that investors cannot escape the reality of what's happening to these markets and frankly they are accountable to their investors. So pretty soon they're going to get called from pension funds, why you're putting out money when the legislator and the business is saying that the market is getting softer. So, I think it's just a different environment than it was in the last cycle.

Your next question comes from the line David Rodgers. Your line is open.

Hey guys and Hamid maybe I don't know if Eugene and Gary want to take some of this too. But I wanted to ask about rent growth and retention. Clearly, you've been driving retention down and driving rents higher. You're down to that point of about 75% retention overall, I think in the first quarter. I guess maybe give us a sense for how that compares across the regions and then also if you could just talk about how that you might level off here in terms of the pushback that you're seeing from tenants moving into the second quarter?

David it's Gene. Let me start and Gary can pile on. So historically we've got to put this in context. Historically 75% retention is the number of people actually seek to achieve. So that's a very, very solid level. Now we've been at elevated levels obviously in the 80s for many quarters and if you look at a trend line, we're headed down. But I am perfectly comfortable with mid-70s. Frankly I am comfortable with probably 70% and even a little bit below that because what we're asking the teams to do today is really push rent and be more aspirational in this -- in this environment where we have vacancy rates that we've literally never seen before in many, many markets. So, I wouldn't be concerned about the direction. And so far, at least our activities in terms of pushing rents have bearing fruit and you look at the rent change look at that. In terms of how that's distributed across the Americas, I'd say in the U.S. you frankly it's pretty consistent across markets. In Mexico, we have much more trouble pushing rents right now. That's really a Peso effect and Brazil has a challenging economic and political background. They're not pushing rents there at this point. So, Gary, I don't know if you would add.

I would say for Europe, we're in a position today where we are trying to push rents in most markets. So, you can see that coming through our numbers. Obviously, occupancies are high. From a market rent growth perspective today, Europe in 2017 we're forecasting of just under 2.5% accelerating here to above 3%. So, things are heading in the right direction certainly in Europe. In Japan, candidly market rent growth is probably around 1% and we're forecasting about the same next year will be different market to market, stronger in Tokyo, less strong in Osaka. And in China, again market rent growth is accelerating. It's probably around 3.5% today and it's going to go over 4.5% next year. So, I'd say arrow up on market rent growth and given the strength that we're seeing in occupancies we will be pushing rents in most of those markets as well.

The only comment I have to add is that if retention had to come in at 80%, I would've been all over these guys that were not pushing rents high enough. Frankly we would have been running it too high and just facing taking the rents as they come. So, we're pushing term, we're pushing credit. Somebody if we have the lease that are concerned on renewal with a tenant we're going to replace them with a high credit quality tenants. So, I look at the lower retention as a positive sign and I actually wish that it were even lower rate.

Your next question comes from the line of John Guinee. Your line is open.

Great. Hamid, because of the butchering of the name I'll get 17 questions for you. So that is full shorter than last time, but we can't. This is a development question, I am looking Page 23 and Page 26 of your supplemental. First on the land it looks like half of your land at share is South Florida, Central Valley, Mexico, Brazil, the United Kingdom and Japan.

Well you just covered half the world economies.

Do you own the right land in the right markets? And then the second question as a sort of a second part of this question, if I'm looking at your development portfolio, can you give a little more color on what you're building where? For example, you've got 6.2 million square feet under construction on the West at about $76 a square foot, which seems kind of low to me. Exactly where is that development being built?

All right. Let me make two general comments and then turn it over to other for more specific color. First of all, seriously the markets that you went through Japan, West Coast, Florida and all that, if you had to mile up together, they all probably have the world's economy. But there are two really, really big and significant land positions we have. One is Beacon Lakes in Florida and one in Tracy which is the REIT -- and which relates to your $76 a foot type question. It is low because the land in Tracy at this point is pretty much free because we've pretty much returned our total investment on that land and I know the accounting doesn't quite work that way. But the land at Tracy is like a good $30 a foot of FAR on their market. So, it should be $100 a foot and $70 because we got really good price of land and by the way, we have another 800 acres of it for free. So, you can see us do a lot of business at very attractive land basis over there. Beacon Lakes is not quite as dramatic as that, both in terms of size and the advantage of the land value, but it is significant and those are the two large pieces of land and do you guys want to talk about specifics?

Yeah just to give you a little color John. This is Gene, if you look at the overall land bank, we had too much land in Mexico and we're working down as quickly as we can. We have a lot of land in Brazil, but we control much of that through effectively land JVs. So, we're not like carrying that land and that's going to be -- we're going to make a lot of money on that land over the next five years obviously in the last couple of years, not much activity. In terms of what are we building where, Hamid pretty much answered the question. The low cost per square foot is driven by really two things. One, we have a ton of activity out in our park in Tracy, California, which is in the Central Valley. And secondly, we have a really, really high percentage of build-a-suit right now. I don't know Mike if you some color on that, but build-a-suits tend to be bigger and they tend to have lower values per square foot.

Maybe just to tie it all together, for broader view John, overall mix globally is going to be 45% of Americas, 25% Europe and 30% in Asia, which is very comparable to last year. Often, we start with margins in the quarter at 19%. In fact, those are normalized in the 16% range over the year and Gene's comment on build-a-suit, we were at 77% build-a-suit in Q1. That was a function of a lot of continuation of a very successful build-a-suit program. We expect that to normalize over the year in the mid-40s, but I would expect that to be higher than our build-a-suit percentage last year. So, net, net, I think we feel once again good about the mix and the quality of our development volume and the quarter here on NAIF.

On the overall land balance, I would say there is a $150 million of land that we have, that I would not buy all over again. I think the rest of it we're totally good with and we think is going to be a great driver of growth for our portfolio. But there is probably a $150 million of it that with the benefit of hindsight win by and would be disposing over time.

Which is less on sellers that we had at the merger of that stuff. So, we got through a whole bunch of that.

Your next question comes from the line of Craig Mailman. Your line is open.

Hey guys. Just curious looking at the starts in Europe, it looks like it was 100% build-a-suits and I know you guys been pretty positive on what you're seeing over there. I'm just curious this is a trend that's likely to continue and maybe what it really indicates here as you look at the existing stock versus kind of the tendency that is doing with the build-a-suit to you guys and where are those build-a-suits. Are they more infill or are they more bulk?

Yeah, I would say that they're -- look we're a 100% build-a-suit. We're not forecasting a 100% build-a-suit for the full year. I think we're going to end up some of the 15% to 16% just like last year. They're spread all around Slovakia, the Netherlands, Italy and the U.K. So going back to the earlier question, is our land in the right place? Of course, it is. If you're doing 50% to 60% build-a-suit on land that you own, by definition your land is in the right place. Most of this I would describe as infill as opposed to bulk. Candidly most of this had to do with retail. It was apparel. It was consumer good and actually one was automotive.

Your next question comes from the line of Manny Korchman. Your line is open.

Hey Tom, a question for you. If we think about capital deployment, especially outside of guidance, do you have an event like the NAIF buyout. Is there anything like outside I contemplated in or out of guidance sort of a big bulky plan like that and B, why are you excluding that from guidance?

So, don't anticipate any other transaction like that. That was not in our initial guidance because that came together quite quickly with discussions with our partner, but don't anticipate any other large transactions like that during the year. The reason why we don't put it in our guidance per se as an acquisition because those assets are already reflected. They're consolidated on our balance sheet. They're all there. So, we don't reflect them as an acquisition because we're not adding to our portfolio. We're just taking a bigger piece of the portfolio. So that's why we describe it separately and don't try to confuse our acquisitions, which are real incremental adds to our portfolio.

But these things just to be clear, I don't want you to take from what Tom said that we're asleep over here and we're not looking at opportunities. If the right opportunity came along and we could buy it at the right number or we could finance it appropriately at the right number and finance it appropriately at the night right number, we would look at all of those opportunities and we have been looking at all those opportunities. And just that we don't know about any of them right now, but we're always looking and we're always working on things.

Your next question comes from the line of Vincent Chao. Your line is open.

Hi. Good morning, everyone. Just seeing with that the line of thinking about the right opportunities coming along, just curious if there are other larger end deals out there that are interesting right now outside of your funds. Clearly a global logistics properties is undergoing a strategic review, but just curious how that factors into the thinking?

I can't think of a significant transaction in the industrial sector in the last three or four years that we have not looked at thoroughly underwritten and had a point of view on. So, you could expect us to be looking at everything. Now we're very selective about what we pull the trigger on, but let's leave it at that.

Your next question comes from the line of Eric Frankel. Your line is open.

Thank you. Hamid, could you -- I think the term last mile has certainly gotten some legs over the last few quarters, and it's generated a lot of investor interest in this sector. Could you qualify the term further in terms of what type of functionality and what kind of demographics around the building would really qualify as a facility that would facilitate the delivery of packages to consumers?

The need to be located in a market with a significant population and a high level of affluence, college education, Internet usage, connectivity etcetera, etcetera, it needs to be dense, it needs to be supply constrained either physically or politically because of the nature of its residents. So putting all those filters on the markets in the U.S., I would say the top markets would emerge as San Francisco, Seattle, New York, Miami, possibly Chicago, parts of LA. And the buildings, there is no rules that I can give you about the type of building you will be in terms of size or number of stories, but the new varieties are likely to be multistory. They're probably not as important to have dock height access and demand in smaller truck access and they need to be near thoroughfares. In terms of -- in terms of rent potential, it would be trading really significantly at the different price points at it -- if you will 10 mile out type of real estate. In other words, there needs to be a pretty significant rent gradient and there are some markets who are being close to the center action or not being that far away from that don't have a rent gradient because basically it's a very suburban eyes market. It's very spread out like it's tough to imagine last mile and Houston even though it's a big city and hits a lot of the other greats here because it doesn't have the supply constraints and the concentration of population in neighborhood, it's very spread out. So those would be the criteria and I got to tell you, they are -- it's unfortunate and you've seen us use the word last tough more than last mile because last mile is really not a last mile. It's last drive or 10 miles and it's really the last touch before you hit the consumer directly. There is a lot of really awful old, tired real estate that it rebranded as last mile we always get a chuckle out of that when we these packages come around. So, a lot of those properties don't meet the criteria that I just spoke.

Your next question comes from the line of Ki Bin Kim. Your line is open.

Thanks. Good morning, everyone. We talked a lot about that last mile and different markets and supply and demand, but Hamid when you look at the industrial landscape besides development, just more market specific and maybe asset quality, where do you think the best places are to put your capital to work and what I mean by that is it still kind of A assess in A markets or has it gone down to maybe A assess and B markets. So just how do you think about that.

Look, the real estate market is not that different than the bond market. When the waters are warm and calm, people get a lot of courage and people really stretch for pricing of the assets. All fear goes out of the market. Junk spreads collapse and the yield premia of not so great real estate collapses on top of prime real estate etcetera, etcetera. We have been in one of those environments for some periods of time. So, I do think junkier real estate has had a rally just like junk bonds have had a rally. When there is a little bit more fear in the marketplace and people sort of gravitate towards quality, those spread roll out and prime real estate will do better. We're not smart enough and we're certainly not agile enough at almost 700 million feet to trade around that. You guys may be in terms of the stock, but we're not. So, we need to set the strategy and execute on it because we can't trade around the site portfolio we have. Our view is that in the very long term, having infill real estate near the population centers in these quality locations with supply constraints wins regardless of possibly one year out of five or two years out of five when the junk rallies. In the long term, you get much better adjusted returns by being in these markets. And we think in our estimation the cap rates historically if you average it over long periods of time, have been far, far more than compensated for by the higher growth rate of those markets. So yes, you pay the premium in terms of the lower cap rate, be in those markets, but you picked up double maybe 250% of that in terms of incremental growth rate. Just look at where you are today in Los Angeles or San Francisco with respect to those -- where those rents are compared to Memphis just to begin, Memphis, when I started my career in 1980, the rent at Memphis were probably higher than they are today, but not in these supply constrained markets that we talked about. So, if you're playing a long game, not a quarter-by-quarter game, you want to have money invested in supply constrained markets where people want to live and this is going to become much more important as the winners in industrial space are going to be more on the consumption end because of eCommerce than the production and which is the way the world used to work in the old days.

Your next question comes from the line of Neil Malkin. Your line is open.

Hey guys. Thanks for taking the question. Just given the focus and bias toward the end consumer, can you give us a flavor or feel for how much of your portfolio currently is that and consumer versus bulk supply chain and how that also stacks up in your development pipeline, I guess if you just focus on the U.S.?

It is a continuum. There is not a bright spot that one property falls in and one property falls out. I think the best way of looking at that is to look at the global markets, which our share is now almost 90% in global markets and the big regional markets, we don't have any tertiary markets. We've sold all of those. Now within the major markets, about a third of our portfolio is around the 100,000 feet or lower. About a third of it is in that 10,000 to 250 range and the rest of it is in the 250 and up range. I would exclude the 250 and up range even though I can think of a couple of larger buildings that are very infill. But I would say, two thirds of our portfolio meets the consumption. I would say the production and the other way of coming at it other than our properties in the northern part of Mexico there is very little production going on. In fact, Chris what's the manufacturing percentage in our portfolio today?

It's less than 5%.

Less than 5% of our portfolio is oriented towards manufacturing. So by definition, the rest of it is on that consumption or in the wholesaler end of the supply chain.

Your next question comes from the line of Rob Simone. Your line is open.

Hey guys, thanks for the follow-up. Tom this one might be for you, but I was wondering if you could expand a little bit on the tick up in free rent this quarter over last quarter? I think it was about $20 million versus $14 million last year and I guess given where you guys occupancy is today and in that most of the leasing already being completed, I guess you would have expected that tick down. So, I am just looking for additional color and what should we expect going forward?

Yeah good question, so when we report free rent, straight line rent, that's reported on leases that commence in the quarter, so which is different than what we report when we lease signings right. So, the leasing activity reported lease signing. The straight line rent, free rent is a function of leases that commence. So, when you look at Q4 versus Q1, Q1 had almost 50% more lease commencements happening right. Q1 is our biggest role. We signed those leases well in advance of Q1. So, the signing showed up a quarter or two ago, but the actual commencement is what triggers the straight line rent free rent. So that's what's driving that aspect of it. When you look at concession, I don't have the numbers offhand, but concessions are clearly continuing to tick down right. Even though you're seeing those numbers grow it's a function of commencements, but also we're signing longer leases. Leases are also increasing right. Rents are going up dramatically. All that increases your nominal amount of rent, but when you look at that concession relative to the whole value of the lease, clearly, they're ticking down.

Well, we were just having this conversation earlier. We're going to just put that out in the package next time and show its trend over time because it's obviously a question that comes up every call and we need to just show it to you.

Your next question comes from the line of Sumit. Your line is open.

Okay. It's me again.

One question now.

Yeah, yeah. They got the name right, so sticking with the old cynical thing and not looking at the bright side of life from the Monty Python thing, I guess how of -- we spend a lot of airtime on last mile and definitions have been exchanged and you mentioned a bit about multistory warehouses. I guess what I'm wondering is how much of this stuff is if you look at some of the experience in London versus Asia, Asia it's done well, but in London it's been viewed as a bit of a science experiment, particularly some properties next to Heathrow had issues with ramps and such. So how do you mitigate that as you are looking towards I'm hoping more builds of that nature in the U.S. judging by your comments?

So, let me give you a story, which you may find amusing, but the developer of MX 2, which is the building you're referring in London went to Singapore is now almost 10, 12 years ago, literally asked us to give them a tour of our Alps project in Singapore, which we did. It took the plans and built the same building in London without thinking about the differentiated truck sizes in those two markets, which is why MX 2 stays on lease for as long as it did. That's the story you can file away. The person in question is no longer in the business. So that's what happened and that building -- why that building didn't lease. It was the wrong building in the wrong pocket. I think it's all a function of land values. I think when land values get to a certain point, multistory will make sense and there are a few markets in the United States that are approaching that point. Obviously in Japan you've got the benefit of smaller trucks and very high land values. So that's why you see the five or six or seven story building. I think you're not going to see that in the U.S. anytime soon, certainly not in my career in bulk. Oftentimes people have asked what's the size of that opportunity? I think there are probably five or six obvious markets in the U.S. where that opportunity exists I think I mentioned them all before. In those instances, it is not hard to imagine that eventually it could have a portfolio of three, four, five million square feet and I'm talking 10 years out. So just for thinking purposes if you got five or six cities at three to five million, you got 20 to 30 million feet of product that is multistory in these major markets and the value of that product is about double what it is for our traditional investor product in our portfolio. So, in terms of value, we could end up being about 10% of the business order of magnitude, incremental over time. That's the best I can do to size the opportunity set for you. Time will tell how successful we will be, but I think we'll be really successful.

Your next question comes from the line at Eric Frankel. Your line is open.

Thank you. Just two very quick follow-ups. One, what is for your multistory development in Seattle you just started, who are your, who are the tenants that can possibly take that. I can only think of three at this point that are really big parcel delivery companies. So, it's Amazon, UPS and FedEx? And then second on the supply front, do you see opportunities down the road for potentially helping some of these developers recapitalize some projects if they feel like they got over their skis and the profits that developers have underwritten or maybe little bit aggressive?

I think those developers will do fine because they’ve got some institution's money and it’s the old-fashioned game. If it works on the upside, they have their promote and equity interest and if doesn't work on the outside, they got some fee upside, they got some fees and got going for a while and the institution which is oftentimes a pension fund through an advisor ends up beating it. So, I don't think there's going to be a lot of distress because these are by and large not heavily bank financed deals. These are more institutionally financed types of deals. So, I think you'll have some disappointing returns for the investors and hopefully they won't finance them next round of development. I think that's going to how it -- that's how it's going to resolve itself. In terms of your first question, could you repeat the first part of your question?

Customer composition.

Oh, just stay tuned. I think our issue right now is trying to figure out how to respond to the interests in that project. So, when I am at liberty to talk about it I will.

Your next question comes from the line of Manny Korchman. Your line is open.

Hey just wondering in terms of demand from capital or institutional investors for product, I think Hamid earlier you had said that there's demand ahead of the supply and so developers are getting comfortable building more supply. If we were to take that same analogy I guess and think about capital? Is it more capital chasing assets and their supply of assets? Is that a fair assumption?

Well yeah and that's why cap rates that we keep saying are stabilizing, are going down because the way the capital is pushing those cap rates down, but we don't blame -- we're not building our business around cap rate compression and rents growing at 10%, 12% a year or like they have been. I think we've shared our assumptions with you. They're essentially based on flat or slightly uptick in cap rates and moderate rental growth, it varies by market, but sort of in that 3% to 4% or 5% range in the U.S. market by market. This is market rent. Same-store will actually be pretty much baked in at somewhat higher because of -- because of the mark-to-market obviously. But happy to go through those assumptions, but we're not building a business around the market being exuberant going forward. I think our assumptions are much more sobering.

There are no further questions at this time. I'll turn the call back over to the presenters.

Okay. Great. Thank you for your time and interest in the company and good luck with earnings season. We'll see you all around pretty soon. Take care.

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