Prologis, Inc. (PLD) Q2 2017 Earnings Report, Transcript and Summary

Welcome to the Prologis Q2 Earnings Conference Call. My name is Cynthia and I will be your operator for today’s call. At this time, all participants are in a listen only mode. Later we will conduct a question-and-answer session. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Tracy Ward. Tracy, you may begin.

Thanks, Cynthia and good morning, everyone. Welcome to our second quarter 2017 conference call. The supplemental document is available on our Web site 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, Chris Caton, 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 second quarter results press release and supplemental do contain financial measures such as FFO, EBITDA 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 thank you for joining our second quarter earnings call. I’ll cover the highlights for the quarter, provide updated 2017 guidance and then turn the call over to Hamid. We had another strong start with core FFO of $0.84 per share, which included net-promote income of $0.18. Net promote income came in above our guidance due to higher real estate values in our USLF portfolio, as well as $4 million promote from our FIBRA that was not in our forecast. Core FFO, excluding promotes of $0.66 per share, up $0.03 sequentially, driven by same-store NOI growth. We leased almost 47 million square feet during the quarter and have just 4% of the portfolio rolling in the second half of the year as our customers are securing space well before their leases expire. As we’ve discussed on previous calls, our strategy has been to push rents to maximize overall lease economics. And as a result, occupancy could decline modestly. Our operating results reflect this strategy. Global occupancy at the end of the quarter was 96.2%, a sequential decrease of 40 basis points. Market rent growth exceeded our expectations, which help drive our share of net effective rent change on rollover to a record 24%. The U.S. was 29%, the sixth consecutive quarter above 20%. Our share of net effective same-store NOI growth was 4.6%, primarily driven by releasing spreads. U.S. led the way with growth of 5.2%. Moving to capital deployment for the quarter. Development starts were the highest quarterly level in the last several years at approximately $900 million. Margins on both starts and stabilizations continue to be very good at over 20%. Dispositions and contributions are on track as buyer interest remains strong and cap rates continue to compress. Recall, we’ve been focused on streamlining our ventures into fewer more profitable vehicles. I’d like to discuss two transactions that further this initiative and highlight our unique ability to source capital through this business. First, as previously announced, we entered into an agreement to acquire the remaining partner’s interest in our Brazil platform for approximately $360 million; second, after quarter end, we contributed $2.8 billion in U.S. assets from our former NAIF fund to USLF at stabilized cap rate of 5.4%. This valuation was structured to be consistent with the buyout of the remaining NAIF investor in the first quarter of this year. Investor interest was very strong and USLF raised over $950 million from 14 new and existing investors to fund this transaction. We received cash proceeds of $720 million and additional units valued at $1.2 billion, which increased our interest in USLF from 14% to 27%. Our current ownership leaves us with another $1.3 billion of built-in liquidity as we redeem our position down over time to our long term target of 15%. Turning to capital markets. We continue to access debt globally at very attractive rates. We completed $2.9 billion of financing activity with the vast majority denominated in sterling and yen. As a result of this activity, we extended our term, lowered our rate and increased our U.S. dollar net equity. Leverage, following the USLF transaction, was approximately 25% on market capitalization basis and debt to adjusted EBITDA with gains was less than 4.5 times. Our balance sheet has never been stronger with liquidity of $3.7 billion and significant built-in capital from future co-investment rebalancing. As a result, we're extremely well positioned to self-fund our future deployment for the foreseeable future. Moving to guidance for 2017 which I will provide on an our share basis. We're increasing the midpoint and nearing the range of our year-end occupancy forecast to be between 96.5% and 97%. We now expect same-store NOI growth for the year to be approximately 5%. Cash same-store NOI growth should be over 6% for the year as a lag from longer lease terms and steeper rent bumps begins to close. Given the increase in market rents, our in-place leases are now under rented by 13% globally and 17% in the U.S. This further builds our organic earnings potential and will drive strong NOI growth for the next several years. Given continued strong demand from customers, we're increasing our starts guidance by $200 million to range between $1.8 billion and $2.1 billion, built-to-suits will comprise about 45%. We're also increasing our disposition and contribution guidance by $250 million in total. Full year deployment guidance excludes the contributions to USLF and the planned acquisition of our partner’s interest in Brazil. Our strategic capital net promote income will be $0.16 for the full year as we have no other promotes scheduled for the remainder of 2017. Again, I want to highlight there'll still be a difference in the timing of promote revenue and its related expenses. We will recognize $0.02 of additional promote expenses over the balance of this year. Putting this all together, we're increasing our 2017 core FFO by $0.05 at the midpoint and nearing the range between $2.78 and $2.82 per share. The main drivers of our guidance increase includes $0.03 from higher promotes and $0.02 from core operations. Our revised guidance, excluding promotes, represents year-over-year increase of 9% at the midpoint. To wrap up, we had a great quarter and are entering the second half of the year with strong momentum. And with that, I'll turn the call over to Hamid.

Thanks, Tom and good morning, everyone. I'd like to spend my time with you today sharing my perspective on the current state of the industry and trends that will affect its future. Market conditions in the U.S. continue to be very strong. We remain vigilant in monitoring potential risks to development starts and oversupply. During the first quarter, we called out several markets with elevated construction starts. But this trend did not continue into the second quarter. On the margin, we’re now even more positive on fundamentals. We're hoping our 2017 forecast as net absorption is constrained by the lack of available space, but we're slightly increasing our expectations for both supply and demand in 2018 when the higher volume of completions will offer more space for customers to absorb. Supply and demand will effectively offset one another and we expect to remain at historic low levels of vacancy. As we discussed at the outset of 2017, we expect that the rate of market rent growth to moderate as the rent cycle matures, and the difference in performance between the best coastal markets and the rest of the country to expand. Our forecast is proven to be too conservative as record low vacancies mean customer have limited alternatives. We see increased activity from our customers and a greater willingness to pay up for quality spaces and locations. Our initial forecast for 2017 called for market rent growth in the U.S. of 4%. Instead, rent growth is on pace to approach 8% this year, driven primarily by high barrier coastal markets, such as New Jersey, Los Angeles, Seattle and the same Cisco Bay area, where we have dominant market positions. Outside the U.S., market conditions are also favorable and the institutional capital continues to chase logistics product, driving cap rates to all-time lows. On the operating side, notwithstanding the quirky quarterly end occupancy stats which doesn’t reflect the additional 450 basis points of leasing we've already completed, Asia remains in line with our expectations. Europe experienced record net absorption and we’ve seen surprisingly limited development starts on the continent. The election result in France is constrictive for economic expansion, which is expected to read nice growth. The UK is the one market that has called slightly and it's coming on several years of exceptional fundamental. Recently, I’ve been fielding many questions on drivers of demand for our product and would like to offer a few observations. I think of demand in three categories; consumption, cyclical and structural. Historically, our business has been highly correlated with consumption and serving basic daily needs as populations grow. This includes categories such as consumer products, food and beverage and apparel. These segments will continue to expand in line with population growth, shifting demographics and consumer confidence. Requirements for our space are also driven by spending on segments that are more closely tie to economic cycles, like residential construction and autos. Logistics space needed for residential construction will increase as the housing recovery accelerates. Housing starts still need to rise by 30% to normalize to a level consistent with population growth. By contrast, we're keeping a close eye on the auto segment as declining sales may dampen growth. Net-net, the changes in housing and autos should be a positive for demand. The remaining drivers are structural and involve fundamental changes in the way businesses operate. E-commerce will remain the most significant of these drives as shopping habits continue to shift online, and will be future energized by millennials for entering their peak spending years. We do, however, expect that the 3x multiplier on demand from e-commerce, that we’ve identified in our research, will decline overtime as customer become more efficient and online sales cannibalize some of the space required by bricks-and-mortar retailers. Lastly, I want to highlight healthcare as a potential new structural driver in the future. We expect its category, which currently represents only 4% of our space, to grow as baby boomers age. In closing, I feel great, even better than last quarter, about the trends that will drive ongoing demand for logistic space located close to end customers. Our portfolio and strategy will further bolster our performance. With that, let me now turn it over for your questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Craig Mailman with KeyBanc. You may begin.

Maybe if we could hit some of your commentary on leasing and rent growth here. Maybe if you could just give us a little bit of color, where you are seeing tenant spike for spaces at only in infill locations, or is it more like Inland Empire market? And then maybe you could also address the 3X multiplier decline there. Is that a function of some of these ecommerce guides Whole Foods, Amazon type deal where they’re just going to buy brick-and-mortar, and do more of a hybrid model over there?

Let me take the last part of your question first, and then I'll turn it over to Eugene and Gary to talk about the first part. The 3X is coming down really for three reasons, one, their infrastructure is going in for us. So obviously, there is a lot of space demand. And then the sales are going to follow. So the online customers are squeezing more volume through the warehouses and they’re getting more efficient in how they use their footprints. There are also technologies emerging that are going to make returns smaller, as smaller portion of returns better fit, better sizing, et cetera, et cetera. We’ve talked about that, obviously, virtual reality and augmented reality are two big ones that overtime will affect the return ratio. So those are two biggies. Also, when you get the 3X expansion of ecommerce, you were getting cannibalization on the bricks-and-mortar end. So you have the offset of the 1X happening at little bit later and with a delay. So I think overtime it is likely for that 3X to end up being somewhere in the low 2s, but that’s going to be a decade long process. So still very positive, still any multiple bigger than one is a strong tailwind, and we think it's going to stay way above two, and it's going to take a long time to gravitate that. Now, let me turn over to Eugene and Gary.

So on the rent growth question, in the U.S., we have pricing power in lot of markets. In fact, we have pricing power in most. And most U.S. markets are in 6% vacancy range or lower, and that’s where your pricing power is. But clearly, the global coastal markets, as mentioned in the preliminary remarks, are leading that. And to give you a sense of it, the first half of this year leasing rent growth in those markets at nearly 7% just in the first half of the year. And they all trend towards 10% the year. So no question, more power there and good example of the L. A. County that’s a billion square feet of real-estate that has about 1%, so tremendous pricing power.

And then in terms of the markets, I'll discuss on Europe real quick. The Northern European markets are very strong, Germany, the Netherlands, the UK is still quite strong. Candidly, I would say that companies are starting to compete for space on a broad base basis across Europe. It's one of the strongest markets that I've seen in quite a while. Market vacancy rates across Europe have dropped to 5.6%. They've got a down wheel on them as we approach the back half for the year. So we're now in a position where we're actually pushing rents. So our own portfolio is performing well. We’re over 96% occupied and rate change is starting to come through positively in almost every market. So it's a very good story.

And our next question comes from Dan Occhionero with Barclays. You may begin.

Two question. Number one, can you just touch on the strategic rationale behind increasing your exposure in Brazil? And secondly, could you just elaborate a little bit more on the difference between leased and commenced occupancy in Europe and Asia, and what specifically drove that?

So let me talk about the strategy for Brazil. Nothing new that we, like the Brazil market, that there’s long-term fundamentals. It's been a tough two years, following three or four years of excellent performance, two years of slowdown. We think it's a great entry point into Brazil in terms of doubling down. The currency is very attractive and fundamental are kind of at the bottom of the market. And the political change that they went through and the rule of law and it worked, and that's pretty unusual in many countries. I was going to say Latin America, but may I'll drop the Latin point and just talk about America. So I don’t know, I just think that in terms of entry point, it's very attractive. We wanted to control the platform also because eventually we’re going to recapitalize it. And we need to own 100% of it. So for a variety of reasons, this was a good time to try to accomplish this objective. Gary, you want to talk about…

On the leased occupied spread in Europe, there is not a big new story that we’re sitting at 96.2% occupied and got a 60 basis points spread to for a lease percentage. So typically, you would see some upward movement in occupancy with that greater spread. The real news is in Asia, particularly Japan. If you look at page 16 of our supplemental and you see the Japan today is 92% occupied, but 96.1% leased, that's more than 10 basis points spread. And the story is a simple one. We had a single 1.2 million square foot building, a speculative building that we leased but the tenant had not occupied the building before it moved into the operating pull from the development to the operating pool. So you should expect not only the Japan occupancy to tick up in the third quarter but all of Asia above 95%, so no real big news there.

And our next question comes from Ki Bin Kim with SunTrust. You may begin.

Could you just talk a little bit more about your development pipeline? I noticed a bigger percentage point to expect, I know it's just one quarter and not really a trend but I wondering if you could comment on that. And tied to that, I noticed the development yield is coming down little bit further across the regions.

You hit on a key point there, development stars relative to those is definitely very lumpy, 77% in the first quarter, 35% in the second. Over the year, that 45% as Tom mentioned, that’s indicative of where we see this heading for the year. And in terms of yields, we focused on margins and you see our margins in the 20% range. And through the first half of the year and through the balance of the year, those might normalize a bit into the high teens as we chew through some of the less expensive land. But we feel pretty good about those margins.

And our next question comes from Manny Korchman with Citi. Your may begin.

Can I just go back to your commentary, and realizing that things are outperforming your expectations; what has sort of changed in the 12 weeks since we last spoke that you’d go from talking about oversupply in a few key markets to, no it's not really oversupply anymore. By the way, we think you’re delivering some continue, and not only that we’re going to increase our starts and the proportion of those starts is going to remain 55% spec. So how do we put that all together over the course of time since we last spoke?

Nothing about supply that I talked about last quarter has changed. You will see a rise in supply in the first quarter in those markets that I indicated on the last call. So that elevated level of starts that we saw will translate into those projects that were started, hitting the market in the first quarter of next year, that remains. What has changed is that that elevated level of starts did not continue in the second quarter. The level of deliveries in the second quarter was actually in a little bit lower than the norm, in line with norm but little bit lower than the norm. So that’s pretty easy to put together. With respect to our rent expectations, we call them as we see them. I mean we went into the year thinking that after multiple-year of almost double-digit growth and the rents nearing replacement cost that it was prudent to be banking on less rental growth, and that’s what we indicated in our internal planning. The reality is that in the markets, particularly the coastal markets, it’s becoming very, very difficult to get built in the space. And remember the buildings are getting bigger, much bigger in the cycle. These buildings require lot of land, transportation areas are getting bigger. So all of a sudden, it is very hard to find flat large sites in these large metro areas, and that’s driving pricing power, because product that already exists there is becoming very scarce. So again, we see them as we call them. And it could be back here next quarter, talking about higher or lower rental growth. We don’t have a perfect crystal ball.

And our next question comes from Steve Sakwa with Evercore ISI. You may begin.

I guess just sort of follow up on that. I mean, if supply and demand are roughly in equilibrium next year and the vacancy rate, I think, is probably getting closer with 20 or low. Is there any reason to think that rent growth next year wouldn’t look very similar to rent growth in ’17? And I guess secondly, I noticed the occupancy drop in Japan. I am just wondering if I missed any comments on that. Could you just touch on that? Thanks.

The occupancy drop in Japan is a blip, the quirky number in the other quarter. We’ve actually leased that vacancy of a building that came online and the lease is signed, but it doesn’t hit the occupancy statistics till next quarter. So that number, if we were reporting here, that would be 450 basis points higher. And as Gary said, the occupancies in Asia are going to be north of 95%. So don’t even spend a moment on that one. I don’t know what rents are going to be. It's kind of like predicting the stock market to a certain extent. I think all I’m telling you is that the momentum is really good and we are feeling -- we were good last quarter. I got tired of every quarter saying this is the best quarter in my career. And I’m just saying I am even feeling much better than the way I felt last quarter. And the interesting thing about all of this is that with every passing quarter, we have leases that are expiring that were signed at the bottom of the downturn. So you would expect that our mark-to-market would shrink. But given the pace of rents accelerating, our mark-to-market is expanded actually and that expanded mark-to-market not only means that rents are strong today, but it means that the recovery, the glide path for the next three or four years looks really, really positive as we absorb those mark-to-markets. So I think the runway has been certainly extended and somewhat elevated, whether it will continue to get more and more elevated, we’re just going to have to wait. But we’re feeling pretty good.

And our next question comes from Jamie Feldman with Bank of America. You may begin.

Tom, going back to your comments, so I think you had said cap rates continue to compress across markets. Can you give more color on where you’re still seeing that and what’s driving it? And then also, can we expect to see more large-fund transactions in the future, like Brazil and the North American one that we saw?

Let me take that last one. You know that our goal is to get to down to one open-end fund in every major region, and we have two in Europe. So that will be a good place to look, not for certain, but that’s the one that have rationalization I see. Tom, you want to take…

On the cap rates, we’re seeing cap rate, I’d say, modestly decline in the U.S. probably 10 basis much lower Q1 to Q2; probably expect similar levels in Europe but given some transactions that we expect to close; in the third quarter, we would certainly expect Europe more expansion and contraction start in Europe in the second half of the year; in Japan, given some pending transactions as well, we would expect top rates to continue to go lower; and with our other pending transactions that are rumored to be potentially closing in third quarter; in Asia, I think it would also be another strong indication of compressing values for assets, but I’d also say how asset management business get valued.

Well, let's be specific on that. I mean logically we’re basically traded at about 10% to 12% higher than what our internal carrying value for, once adjusted for quality and location to our own internal portfolio. And that leads to in a quarter roughly of NAV increase. We and you are looking for more details on the GLP transaction. But the couple of estimates that were out there on this trade were at 260. Actually that’s their IFRS carrying value on their portfolio, which is mark-to-market and the rumored price is 330, something. So there is a 30% difference there in valuation. So I'm not saying that -- we don't have perfect visibility in business transactions, but those bode very well for values outside the U.S. So the cap rate compression issues are much greater or the compressions are greater outside the U.S. than they are inside.

Jamie, one thing I just would add. What's really driving the compression, particularly in the U.S., is rent growth. And I think given the trajectory of rent growth, higher rents, higher rents are causing valuations to go up and cap rates the cost of that for higher growth expectation.

And our next question comes from Nick Yulico with UBS. You may begin.

Just looking at your re-leasing spread on a cash basis is highest you've reported this cycle. And you talked about rent growth being even better in the U.S. this year now on track for 8%. So hoping you could give a little bit of perspective on how your mark-to-market spread might look for remainder of this year and even heading into next year?

So if you're talking about mark-to-market for rents, basically where we are right now looking at our re-leasing spreads, if rent is growing market rents are growing more than 4% or 5% that spread will expand. And that's what we saw in the first half of the year and that's opposite of what we expect. So this year for sure, it'll stay where it's at and maybe expand a little bit. But that's a bit of a threshold that I want to keep 4% or 5% in excess of that you're going to see the mark-to-market.

Our mark-to-market in the U.S. has gone from 15% to 17%. The overall has gone from 12% to 13%, 14% today as we sit. If those trends continue, it could approach 15% as we crossed into 2008.

And our next question comes from Sumit Sharma with Morgan Stanley. You may begin.

Hamid, to your comments on the 3X number, I agree, I think it should over time tend to go down just as the supply chain models achieve greater operating leverage. But what caught my attention was you said returns would be one of the variables that bring it down slightly. I guess if returns are just 30% of ecommerce gross merchandize volumes, and my sense was this was always on the fringes of the supply chain with facilities being located away, more labor, everything that points to a sleepy corner of warehouse land. I'm struggling to understand how this materially moves the demand variable, or did I misread your comment?

No, I think the returns are very space intensive, because the inventory needs to be accepted unpacked, restocked and all of that is labor intensive and space intensive. So as technologies allow fit to get better, particularly with the apparel, I think returns are going to go down and that on the margin will affect the amount of the space in the warehouse that's devoted to handling returns. So that's really what's going on. But that's a very long process. I mean some of these technologies I'm talking about don't really exist today, or they exist in very limited ways.

And our next question comes from John Guinee with Stifel. You may begin.

Great, okay…

Let me just say that that was absolutely the best rendition John that I've ever heard.

Tracy is going to allow me two questions I'm sure. Refresh my memory, Hamid, have you turned 60 yet, because your stock just did?

Unfortunately, I lost that bet. I’ve turned 60 about nine months ago.

And then second, Tom, your revised net earnings estimates about 280 a share. Are you able to shelter all those gains via 1031s, or would we expect your $1.76 dividend to increase, one way or another?

No, we do not expect any special dividends we can shelter that income. The big increase that you're seeing in our EPS guidance is the expected gain, book gain on the USLF transaction, that’s about $0.87. But we can defer that gain, because the vast majority of that gain, we sold down roughly a third part of the $2.8 billion we put in there. So the other is just basis switching out from direct ownership to indirect ownership. So that gets sheltered.

But I think the gist of your question is still valid. It is not a piece of cake to manage or dividend around here. We’re devoting more and more time on deferral strategies, 1031s and all that. I'm not a big fan of special dividends, but we try to make our dividend policy to be pretty stable, reliable and consistent as it's been in last couple of years.

And our next question comes from Blaine Heck with Wells Fargo. You may begin.

Just wanted to touch on the increase in development start guidance. Hamid, given what you're seeing with higher than expected rent growth and also what's on the horizon is our supply and demand dynamics are concerned. Do you think this case of starts that you're guiding to this year is sustainable into next year, or do you think this is likely to be the peak level for you guys?

I think in the depths of the downturn or shortly thereafter in 2010-2011 time frame we had an Analyst meeting in New York and at that time that’s even before the merger, we said that the responsible level of starts given our global platform is going to be between $2 billion and $3 billion depending on the day in the cycle. And that’s been where we’ve been, sometimes it's in the low 2s now it's approaching mid to high 2s. We make the development decisions from a bottoms up opportunities identified in the marketplace. We do not sit around this table with the executive team and say, we will drive to, I don’t know, $3 billion of starts. I think that approach was tried in previous cycles and what shows in that be a very successful way of doing developing. So bottoms up, deal-by-deal and they have to pass a very rigorous test for market conditions and competitive set and the like. So that’s a long winded answer. I don’t really know what development starts are going to be next year, but we’ll have a better idea of when we rollout guidance towards the end of this year. Mike, if I were going to guess, I would say it would be between 2 in the quarter until now. It’s really tough to find win in some of these markets.

And our next question comes from Michael Carroll with RBC Capital Markets. You may begin.

Can I also, the last question, look like the Company is being a little bit more aggressive starting projects outside of the U.S. with about half of the deals in Europe and Asia year-to-date. Is there anything to read into that?

In the last 15 years, this is a little secret of our business. Two thirds of our starts have been outside the U.S. and about 75% of our value creation has been outside the U.S. And I just am amazed that I get questions about why you’re global, because we make a lot of money developing outside the U.S. There is no logistic supply chain much smaller than the U.S., so the opportunities and the run way is actually pretty big outside the United States.

Just to add, I would say, the markets are very tight. And if you look at the first half of the year for us in Europe, we started 11 buildings -- we started 13 buildings, 11 of them were built-to-suits. So there’s just not space available for our customers so were having to build it. And I would say in China the market dynamics are good for speculative in Japan we’re doing more built-to-suit as well. So it's a pretty well fostered strategy, I would say.

Probably what I’d point out is that while there was a quite a bit of international activity this quarter, the long term next several years that has end up at 45% Americas, 25% in Europe and 30% in Asia, which is pretty consistent with our vision 2020 long view. So give you a perspective on how that looks over the long haul.

And our next question comes from Michael Mueller with J. P. Morgan. You may begin.

Real quick one, back at Brazil for a second. Can you comment on what the pricing was at a buyout? And I guess that the plan is to ultimately recapitalize it anyway, whether the partner that wanted to sell or can you just give us a little more color on that?

The partner, I don’t think it really wanted to sell, but their primary focus is on their other businesses, retail and office. And I'll let them speak for their strategies, their reasons for selling. We see the opportunity as a really good opportunity, and so did they. But they also see significant opportunities in the other sectors where they can execute better. So also the strategy of recapitalizing Brazil, we’ve talked about this for a number of years. And it's consistent with what we’ve done in China and in other platforms in terms of really building a private or public capital vehicle for owning assets long term, particularly in markets where currency hedging and the like are difficult and the debt markets are not very developed. So we want to manage our currency exposure as well. So all of those things will lead you to a strategy of controlling the platform and then recapitalize it. Tom?

Michael to your question, so from a yield perspective think about cap rates for operating assets, stabilized operating assets, cap rates for the nine in front of it. We also acquired land as part of this. So I think the yield on combined basis for the four investments we will make is going to have a seven in front of it. And when you think about total NOI from Brazil going forward after we close on this last transaction for Brazil, we’ll be around 2% of our NOI our share.

Yes, I just wanted to be clear, that seven is a combination of operating assets at the nine and then construction in progress and then land inventory. So all of it blend in together, including non-income producing assets are in the seven, one other thing that I would just mention, because it's related to your question. Although not probably directly, the ability for Prologis to source capital around the world and match it with investment opportunities around the world, it's pretty unique because if you would look at the quarter, we bought out our business, our partner in Brazil and we source capital in the UK. Now, within those two things that fund each other directly, because we manage obviously each debt and asset and liability in each country to manage our currency but if you really think about it, we were able to borrow money in the 2s before for a dozen years in the UK and deploy it in the 9s in Brazil at what we believe to be a pretty low point in the currency. We’re not in the currency speculation business, but it's certainly a lower point than the past couple of years in the cycle. I think that's a pretty unique platform that allows you to do that. And I'm not sure that's totally appreciated out there.

And our next question comes from Eric Frankel with Green Street. You may begin.

Just two quick questions, one is regarding the NAIF recapitalization and contribution to the U.S. logistic funds. The 5.4% cap rate I would assume that's significantly higher than our overall U.S. portfolio. Can you just provide maybe a mix of global and regional markets for that portfolio? And then second, can you explain in accounting terms the difference between your GAAP or you GAAP same-store NOI growth and recapturing high growth? Thank you.

I can give you a sense of the cap rate. So that cap rate is at appraised value cap rate, because that was our deal for buying the last tranche of NAIF. And our deal with new investors was that they'll get the same pricing and we turn that around in like 120 days by the way. So let me just take -- I think this is what you’re looking for. So this cap rate is 5.4%, the apples-to-apples cap rate at the same time of USLF is 5.1%, and the apples-to-apples cap rate for all of Prologis is 5.3%. All of those cap rates are now 20 bps, 30 bps lower something like that. As far as the -- I can't give you a market-by-market breakdown, but NAIF has much more exposure to regional market versus global markets than USLF and so that explains. Hopefully, that answers your question.

Eric, on the net effective versus cash same-store NOI, if you just think about over the last several years, we've been building occupancy and rents have been growing significantly. And concessions have been coming down. However, we have been building a significant amount of free rent up over the last several years, because we're signing much higher dollar value leases, concessions are less, longer leases as well. So they are not on the free rent that we have been building up that’s been growing pretty significantly. Now that we’re in a period where occupancy is pretty consistent year-over-year for sure we’ll be there in the second half, as well as the length of our leases are now pretty consistent. We start to see that build-up of free rent online so that significantly starts to add to your cash same-store NOI. So if you just think about having a three-year lease with straight line rent of one month in every year and now you sign a five-year lease and you have half of year straight line rent per year, the nominal amount of your free rent in that five year lease is going to be bigger, so you'll see a hit when that lease rolls. But once you burn through that, your cash growth comes up significantly. So that is what’s happening. I think you’re going to see the same dynamic happen into ’18. So when we talk about whatever our same store growth is for ’18, net effective, you should expect to see cash same store above that.

Let me just add one thing to what these guys said. When the cash was lower than GAAP, you heard from us many times that really that is what you need to pay attention to, because that’s closer to effective rents. Let me say that when cash is greater than GAAP, that’s still same answer still holds. We pay a lot more attention to GAAP around here. We really provide the cash number, because you guys want it but we run our business based on effective rents.

And our next question comes from Vincent Chao with Deutsche Bank. Your may begin.

I know we spent a lot of time talking about market rent growth, but just curious, I mean, it seems that your customers should be at all time high in terms of cost of occupancy. I know it’s not a huge percentage of their business. But is there any benchmark that we need to be thinking about in terms of how far rent growth could go? And then maybe as a coruler to that question, last quarter, you talked about customer retention, which was a little bit lower. Just to make sure you are pushing rents as much as you can, and they were up a little bit here in the second quarter. Is it safe to assume that you haven’t quite found that leading edge of rents pushing rents?

Let me answer your question this way. We had a leadership meeting around here, and we track the reasons why we don’t retain a customer; they wanted too much space; we didn’t have space to accommodate them; they wanted to shrink; they went out of business; so like four or five standard reasons why customers don’t renew. One of them you would think would be because they found space cheaper down the street from somebody else. We could not find one example of that in that quarter. That tells me when we’re pushing rents hard enough. So that we started really, really pushing rents on the margin, because until you start -- by the way, if you love our customers and don’t want to lose our customers. But I mean if we’re retaining all the customers that can be retained, that means we’re not testing the edges of rent growth. And we’re beginning to do a better job of that. I wouldn’t say it's perfect yet. But the pricing pay for that is that your retention rate on the margins is going to come down a little bit. That is totally a price we’re willing to pay.

And Vincent to your first question on, are we at prior peak rents in some markets. Yes, we are. That was a decade ago. We are 35 % below the last market peak inflation adjusted that’s a point. So in terms of -- the price of everything else has gone up, but the customers have had a tremendous bargain for the last 20 years because cap rate compression has given a bargain on rents at the cost of the capital market. So they’ve got long ways to go before they reach real term rents even forget about the peak, but even going back to 1980, real rents are way, way down. So I think this could be a longer term phenomena. But I don’t want to speculate about it.

And our next question comes from Richard [indiscernible] with Baird. You may begin.

You touched about it at the beginning of the call, but I wanted to dig in a little further on the Amazon acquisition of Whole Foods and any potential impacts on their requests for industrial space. As your largest customer, have you seen any changes in their request for the specific specifications in the industrial building? And are there any asks of them where you put your foot down and say no, we’re not going to go there. And secondly, how far are you willing to move down the supply chain to the nearest mile-delivery facility in order for them to accomplish some of their same day 2-hour delivery objectives?

Richard, with respect to the Whole Foods acquisition, we view that as a real positive for industry reinforces the strategy of getting close to your customers, which clearly we’ve been doing for some time. So I think that’s a good thing in general. And we see them getting more and more active in this business as they compete with major players in this field, namely Walmart and this activity should pick-up and resolve in more activity for logistic players like ourselves and others. In terms of working on, here implication is every single Amazon requirement out there we’re very selective on when we work with them. The buildings that end up being a little bit more specialized, we look at selling those. But by enlarge most of business we do with Amazon is in our generic buildings, it’s very releasable and it’s based that we feel like we can use very well. In terms of going down to the last mile, our buildings that could fit in that requirement in our infill location, certainly, are good candidates for that and we will pursue those opportunities as they come up.

Our strategy to go infill multi-story intensify these sites that we’re executing on in Seattle, as you know, the Francisco Bay Area and New York with the former ABC Carpet business, all of those are multi-story buildings are in attempt to get closer to the customer and take advantage of intensification of urban land, which is very scares. So that’s going to happen whether Amazon leases those buildings or somebody else does, we’ve seen a lot of demand for those types of facilities, modern facilities.

And our next question comes from Jon Peterson with Jefferies. You may begin.

So you guys made some comments that you’re pushing rents harder which is why occupancy tick down a bit this quarter. So I think I also heard Hamid note that the quarter end occupancy number was quirky, and you’ve already seen 450 basis points of leasing in the third quarter. So I’m trying to put those comments together and figure out whether we should expect occupancy is trending higher or lower, what the magnitude is, and what exactly the 450 basis points of leasing mean?

The 450 is singing one lease in one building that came online, following its stabilization period that was only 10% leased, that’s now 95% leased. And it's only 4.5% increase in Asia. It's just one building in Japan.

So that was the quirky comment.

Yes, that was quirky. Maybe I should have used better terminology. In terms of our overall strategy, particularly in the U.S. and to a lesser extent in Europe, you should expect our retention to trend down and our occupancy on the margin to trend down a little bit, maybe 100 basis points and our rental growth to be higher than it would have been, as we manage 96%, 97% occupancy and not pushing rents that hard.

But it’s not a perfect sign. And certainly, the numbers from quarter-to-quarter and move around, but that’s what we’re trying to do. What we’re trying to do is be tougher on rents. By the way, no matter how tough we are on rents, we can’t charge above market rents. So obviously, these are market rents that tenants are pay. It's just that they're higher than what we thought previously.

The only comment that I would make with respect to calendar year 2017 is that occupancy probably going to stay relatively flat, certainly going into the fourth quarter and even trend up a bit. And the reason is that we really have very little to lead -- very little role.

We only have 4% of role.

So U.S. is more of a long term cadence about where occupancies might go over a period of time.

And our next question comes from Tom Catherwood with BTIG. You may begin.

Circling back to USLF and the strategic capital business. When it comes to rebalancing your funds, what is the trigger? Are you able to time the rebalancing to match fund new investments, or do we see a gap between rebalancing and putting those funds to work?

Well, we try to match it with investment needs. I mean, certainly, in a place like USLF is today with 27% ownership and -- by the way it's 27 on a big number, I mean that's a $9 billion fund now. So 27% of that is 12 points higher than our 15% where we want to be. So as opportunities come up and we need the capital that's how we dollar cost average out of that fund. By the way, if people think we know how to top-tick that stuff and be really through to that doing that, we don't. I mean it's much more of a strategically driven decision than valuation driven on the last margin. I mean, generally in the next couple of quarters, we're going to be pulling that capital out. And by the way, there's a lot of demand for people who want to invest in that fund. So I think those two things meet well.

And mechanically it's within one quarter. We can execute the redemptions on the quarter.

Yes, from when we want to take a quarter to do it.

And our next question comes from Craig Mailman with KeyBanc. You may begin.

Just one quick follow-up, I'm not sure I'm thinking about this right on same-store here, if only 4% rolling. I mean, can you pull forward a meaningful amount of expirations from '18 to keep the trajectory on same-store on the GAAP base? Or is that the fall off into the back half of the year? And does that just mean that the spread between GAAP and cash widens, or does cash trend down follow it as well?

From a same store perspective, as Gary said, we don't have a lot to place to same-store. The really only variable on same-store in the second half is really going to be on the margin with occupancy, that’s what’s still little role each time the vast majority of what's going to get -- what's going to go in service. So that's happening. I think when you think about the same-store in the second half for our midpoint is going to be 4.8%. And when you think about that number that has all rent change. The first half of this year and prior years, we've seen a boost in our same-store from occupancy gains. Occupancies are now leveling off. So it's all about rent change. So when you think about ’18 rents, same-store should accelerate, because as Hamid said, we have built up in-place to market is -- that gap is wider, which means our rent change on role in '18 is going to be higher than our rent change in role in '17, that's gapping out. So that has to mean our same-store NOI will be higher in '18 than we're going to see in the back half of 2017. So that's really what's going on.

And surely we will pull some leases into the last quarter of leasing like we always do. By the way, the reason the 4% is 4% is because we've already dealt with a lot of those vacancies that by the way is rolled over, and been additive to that 4%.

And so don’t be surprised if you see leasing volume be slower in the second half of the year, because we’re going really from now on, we’re working on 2018 lease renewals.

And our next question comes from Jamie Feldman with Bank of America. You may begin.

Two quick follow ups, one is, looks like you had a spike in turnover cost on leases signed. Can you talk about what happened there during the quarter? And then also you commented that UK market is cold slightly. Can you just talk about expectations for the UK going forward, and what's driving the pull back?

So basically we just had a very high percentage of leases take places in the U.S., the turnover costs are higher. On this metric, I would just point out that over the years, ‘16 to ’17, our turnover cost as a percentage of the lease value is really how we look at it, has increased. But it's down between 50 and 100 basis points in '14 and '15. So we actually feel pretty good about the trajectory there.

Hamid mentioned in his remarks that the UK was moderating a little bit, what is really referencing our market vacancy rates. So if you look at the market vacancy rate today in the UK, it's sitting at 5.9%, that’s pretty good. It's actually fallen 50 basis points from a year ago. But in this specific quarter, it actually backed up by 20 basis points. So we had a light leasing quarter. So that’s really the comment that we're making. What does it mean to our portfolio, literally nothing. We're sitting at about, well, we're sitting at 100% occupancy. Last quarter, we were at 99.5% occupied. We still have long-term leases there, very little role. I candidly wish we had more role because that is one of the markets in Europe where we are significantly under rented to the tune of 10% or 11%. So no bad news for us, but I guess what we’re trying to say is let's watch closely what happens with respect to net absorption in the third quarter and what happens with market vacancy rates in the UK.

And our last question comes from Sumit Sharma with Morgan Stanley. You may begin.

Hamid, you mentioned it was difficult to acquire land and you mentioned there are challenges of that land and such. So to which I would like to point you to this asset class, called malls. So did you guys -- would you guys buy them all on portfolio falls, or did you buy a mall anyway anytime?

I think that’s a lot of question. But as you, probably when you were in high school, we actually invested in malls and in the retail sector and in '99 for that business. But all things aside, there is got to be lots of stages of grief between realizations dealing with the changing values. We can’t afford to buy -- first of all, there are lots of good malls and they’ll do well and I don’t want to be negative one really good malls. But there are certainly some power centers and malls that should be there and they’re two anchor malls and they could be great logistics land. I think the value expectations of the owners and the realities of the economics of our business are pretty far and far. I think it will take a couple of years with those expectations and realities to match up. But I venture before too long. You’ll see some still anchor Class B malls converted into logistics buildings, that is not too farfetched at all and we're definitely looking at some of them. I think that was the last question. And again, thank you for taking the time to be at our call and we look forward to talking to you in the coming months. Take care.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.