Prologis, Inc.
Q1 2013 Earnings Call Transcript

Published: 24 Apr 2013

[Operator:]

Good morning. My name is Michelle, and I will be your conference operator today. At this time, I would like to welcome everyone to Prologis First Quarter Earnings Call. [Operator Instructions] I would now like to turn the call over to Ms. Tracy Ward, Senior Vice President, Investor Relations. Please go ahead.

[Tracy A. Ward:]

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

[Hamid R. Moghadam:]

Thank you, Tracy. Good morning, everyone, and welcome to our first quarter call. The year is off to a great start, and I'm pleased with our results. Momentum is building across all our lines of business. Performance in the first quarter was driven primarily by strong operations and the continued execution of our 10 Quarter Plan, which remains ahead of schedule. Let me first offer some observations on the economic trends that affect our business. Global trade has risen well above its previous peak, and the IMF forecast of growth are 3.6% for this year and 5.3% for the next year. Globally, consumption is also expanding, with e-commerce an increasingly important factor, growing 15% per year in developed markets and more than 25% a year in emerging markets. This is driving new demand for large-scale distribution facilities around the world, first from pure online companies and second from traditional retailers, building out parallel supply chains for their online divisions. Most of these companies are positioning their distribution networks in global markets for expedited delivery, which plays right into our area of strategic focus. Space utilization stands at record levels. This suggests that our customers have less shadow space than normal, which is an important leading indicator of demand. In the U.S., personal consumption and expenditures are 5% above prior peak, and the consensus forecast is for consumption to grow by 2% this year and next. Housing is clearly on an upward trajectory, which starts in sales growing in the first quarter. Real inventories troughed 3 years ago, and today they're still 3% below their precrisis level. This is the only major economic indicator that remains below peak. We expect inventories to surpass previous highs by year end. In the U.S., net absorption in the first quarter was a positive 63 million square feet, 2.5x the comparable quarter last year and the strongest first quarter since 2000. We've not changed our forecast for net absorption of 150 million square feet for 2013, but we may prove to be conservative given the strong start to the year. In spite of surging demand, development remains in check. For the quarter, new supply was a modest 17 million square feet, well below the historic average. The majority of starts were build-to-suit projects. For the year we expect completions in the U.S. of 60 million to 70 million square feet, roughly half the norm for a recovery and in line with our estimates for annual obsolescence. I spent last week in Europe and came away convinced that demand for high quality facilities, combined with a dearth of modern supply, will result in near term improvements in occupancy and, in time, rental rates. Today, we see clear evidence of this occupancy in rental growth in northern Europe and the U.K. The key takeaways from my trip last week were, first, investor interest in investing in European logistics is growing substantially following the closing of our Norges venture. Second, the capital markets are improving. Investment activity has picked up and there is more financing available than the headlines suggest. We're confident this activity will put downward pressure on cap rates as it did in the U.S. 2 years ago. In Asia demand is driven by e-commerce and 3PLs who are reconfiguring their supply chains. Vacancy rates reached new market lows in Japan. In China, net effective rents continue to rise and are expected to grow by 5% to 7% in 2013. In short, we see a new window of opportunity opening with the return of pricing power in most markets. At the same time, we have interest rates at historic lows. These 2 conditions rarely coexist. We believe we are entering the sweet spot of the industrial rent cycle with a period of significant rental growth ahead of us. Let's switch gears now for a brief look into our results for the quarter. Our teams around the globe did a stellar job, leasing a total of 35 million square feet. This volume is 15% higher than the comparable quarter last year. We have the typical seasonal dip in occupancy in our small units. This was due to normal seasonal factors. We continue to believe this segment will experience a considerable boost from their recovering housing market. Demand for our largest properties continue to grow. We're 99% leased in spaces over 250,000 feet and completely sold out our product above 0.5 million square feet. This level of demand is significant for 2 reasons. First, following 17 quarters of rent roll downs, rent change turned positive this quarter, as we had anticipated. Recovery in rent has broadened and now includes most of the markets around the globe. Second, as we indicated at our investor forum, we expect net effective rents to grow by 20% to 25% globally through 2016. The only change from our earlier expectations is that we now believe we'll realize this growth sooner. Rental growth will be the single biggest driver of our future core earnings, and its realization is not dependent on any incremental capital investment. The lack of supply is driving our development starts, especially for the larger buildings. During the quarter, we start more than 310 million of new development projects, with an average estimated margin of more than 21%. Over 1/3 of our starts were build-to-suits. While we don't expect to sustain this level of development profitability forever, our margins point to the low book value of our land bank and the competitive advantage it provides us going forward. We saw the benefit of our land bank with a number of recent build-to-suits, including projects with Amazon, Quaker, BMW and Sainsbury's. In each case our fully entitled and ready-to-go sites were a major contributor to our success. Let me conclude with a few comments on Private Capital. During the quarter, we reached 2 key milestones. We completed the IPO of our J-REIT, which was a tremendous success and continues to trade well. This vehicle will serve as a long-term operating vehicle in Japan. We also completed the recapitalization of PEPR and our European balance sheet assets by forming our joint venture with Norges Bank. This venture underscores the strength of the European investor real estate market and the appeal of our portfolio. To sum up, Prologis had a great first quarter, and we're poised to do well going forward. With that I'll turn things over to Tom.

[Thomas S. Olinger:]

Thanks, Hamid. This morning I'll cover 3 topics. First, our quarterly results; second, deployment and capital markets activity; and third, guidance for 2013. Starting with the results for the first quarter, core FFO was $0.40 a share, $0.01 ahead of our expectations. Net operating income was better than we forecasted driven primarily by higher occupancy. We'd expected occupancy to drop about 80 basis points sequentially in line with the higher lease roll that occurs at the beginning of each year. However, occupancy only declined 30 basis points from year end as leasing volume came in higher than forecast. Occupancy was 93.7% at quarter end. Q1 leasing volume was 35.8 million square feet, which was seasonally strong as Hamid mentioned. Rent change on rollover increased 2% for the quarter. Positive rent change was driven by space sizes 250,000 square feet and larger consistent with where we're seeing low vacancies and limited new supply. For the quarter, GAAP same-store NOI was up 0.3% and, on an adjusted cash basis, was up 1.8%. Cash same-store NOI should continue to outperform GAAP same-store throughout 2013 as we expect further benefits from contractual rent bumps and declines in the rent concessions. Switching gears to Private Capital. Our Private Capital revenues this quarter are up sequentially due to asset management fees from the J-REIT and Norges joint venture. Had both of these transactions occurred at the beginning of the quarter, our Private Capital revenue would have been almost 6 million higher. Following these transactions, about 80% of our Private Capital fees are now generated from perpetual or long life vehicles. Moving to our deployment activity. We had contributions and dispositions of $5.3 billion during the first quarter, with $3.3 billion in our share. The vast majority of this related to the closings of our J-REIT and Norges joint venture. We realized or monetized $247 million of development value creation in the first quarter, driven primarily by contributions to our J-REIT. As you know, our core FFO does not include any of these development gains even though we recognize real economic value from the transactions. To put the magnitude of the development realization in context, the development gains were $0.53 per share relative to our core FFO of $0.40 per share for the first quarter. Development starts were $313 million for the first quarter, with $218 million our share. We're continuing to see more development opportunities and, as expected, our land bank has proven to be a competitive advantage. We have very good visibility into our pipeline and are off to a great start this year for this early in the period. On the acquisition front, it was a light quarter. However, our pipeline is building as there are more opportunities coming to market. Now let me walk you through our uses of our net deployment proceeds. We used $2.4 billion of the proceeds to repay our senior convertible and secured debt, as well as paid down our credit facilities. We retained the remainder of the net proceeds and ended the quarter with $785 million in cash. Subsequent to quarter end, we completed the redemption of $482 million of our preferred stock. This leaves one series of preferred stock currently outstanding with a redemption value of $100 million. As a result of the significant disposition and contribution activity, we lowered our look-through leverage to 37.5%, a reduction of almost 600 basis points from year end, and we improved our net debt to EBITDA to 7.5x, down from 8.8x in the fourth quarter. And we also increased our U.S. dollar net equity to 66%, up from 58% at year end. Our long-term goal is to have this metric over 80%. It's important to point out that while we've significantly reduced our leverage, we've also been able to maintain our core FFO level of $0.40 per share on a year-over-year leases. Now for an update for 2013 guidance. For operations, we're maintaining our GAAP same-store NOI range of 1.5% to 2.5%. We continue to expect year-end occupancy to range between 94% and 95%. On the expense side, we're maintaining our net G&A guidance range of $220 million to $230 million. For capital deployment, our 2013 forecast continues to range from $1.9 billion to $2.4 billion. This includes $1.5 to $1.8 billion of development starts with our share at approximately 75%. Based on the pipeline we see today, we could be at the high end of this range. And $400 million to $600 million of building acquisitions with our share at about 35%. Turning to contributions and dispositions. We're maintaining our guidance of $7.5 billion to $10 billion for the year, with our share of the proceeds to be about 60%. With the activity completed in the first quarter, we're at about 60% of the way through our disposition and contribution guidance for the entire year. The balance of the guidance totals $2.3 billion to $4.8 billion with dispositions primarily in the U.S. and contributions to our co-investment ventures in Europe, Japan, Brazil and Mexico. We've revised our FX guidance and are now assuming the euro at 1.3 and the yen at 100 to reflect the strengthening of the U.S. dollar over the past quarter. This change has about a $0.03 per share negative impact on full year core FFO. We continue to expect 2013 core FFO to range between $1.60 and $1.70 per share. As we discussed last quarter, our core FFO guidance is significantly impacted by dilution from the timing and associated friction of redeploying the proceeds from our contributions and disposition activity. Relative to this, the average annual yield on contributions and dispositions is approximately 6.8%, while the average annual yield on our use of proceeds is approximately 4.2%. These use of proceeds consist of debt repayments, preferred redemptions and capital deployment. As a result of the redeployment timing and friction, core FFO will not be evenly distributed between the quarters for the balance of 2013. We expect second quarter core FFO to be $0.02 to $0.03 lower than the first quarter. Core FFO will increase in the back half of 2013, primarily driven by higher NOI from development stabilizations, same-store NOI growth and lower interest cost. Before I close I want to discuss 2 new disclosures in our supplemental this quarter. The first disclosure relates to our debt-to-EBITDA metric. As you know, development is a key business segment for us. However, its earnings or realized value accretion gains are not included in our core FFO or in EBITDA as I pointed out earlier. In order to correct for this misalignment, certain adjustments need to be made to our debt-to-EBITDA calculation to appropriately reflect our development business. These adjustments are detailed in our supplemental and include increasing EBITDA for stabilized NOI from the pipeline, increasing debt to fund the remaining cost to complete the pipeline and decreasing debt by the book value of the land bank. Using this methodology, our debt to EBITDA was 6.2x for the first quarter. This is the right metric to use to compare us to REITs, who do not have a meaningful development business. The second disclosure relates to G&A as a percentage of AUM. We use this metric internally to measure and manage our overhead cost. We provided 2 ways to look at this metric based on whether you want to use our AUM owned and managed or our share basis. Using owned and managed AUM, you need to include both our G&A and Private Capital expenses in the numerator. This results in 69 basis points. Using our share of AUM, you need to include both G&A and Private Capital expenses, but you must deduct our Private Capital revenues from the numerator, which results in 61 basis points. The traditional way of measuring G&A as a percentage of FFO is not applicable for us given our substantial Private Capital business. To wrap up, I'm very pleased with our results this quarter and the positive impact you now see in our financial position resulting from the progress we made on our strategic priorities. While we have a little further to go to reach our long-term leverage and foreign currency exposure targets, we're in a great position to take advantage of emerging opportunities and to profitably grow the company. With that, I'll turn it back to Hamid.

[Hamid R. Moghadam:]

Thanks, Tom. Here are the key points I hope you take away from today's call. First, the recovery in industrial real estate continues around the globe. This is evident in growing demand in the face of still very modest supply of new space. We're in an unusual phase of the cycle where we benefit from both low interest rates and accelerating growth in rents. Second, the substantial work associated with the merger is complete, and we're ahead of schedule on our 10 quarter priorities. We built a solid foundation from which to grow in the coming years. Third, we believe the scale of our operating platform, the depth of our expertise and customer relationships, and our substantial land bank provide us with some significant competitive advantages going forward. We have the financial resources, both public and private, to capitalize on a growing and exciting set of new opportunities around the world. With that we will open it up to your questions. Michelle?

[Operator:]

[Operator Instructions] Your first question comes from Jeff Spector from Bank of America Merrill Lynch.

[James C. Feldman:]

This is Jamie Feldman here with Jeff. I was hoping you could talk a little bit more about the kind of leasing you did see in the quarter and what you're expecting for the year. I know there's a lot of talk about housing helping demand grow, but maybe just frame how much of your bullish comments are housing related, how much is e-commerce, how much is supply chain redesign, just to frame a little bit more of what's going on out there.

[Eugene F. Reilly:]

Sure, Jamie, it's Gene. Let me take that. I think it's broad-based. Obviously what's really moving the needle is e-commerce because you have a lot of very, very large transactions. So they're driving the absorption in the market, and we're certainly seeing our fair share of that. But we're also beginning to see -- although in this quarter, as Hamid mentioned, we had a normal seasonal decline in occupancy of small spaces, Jamie, I'm actually more bullish this quarter about our prospects for small tenant leasing than I was last quarter. Last year, I think we dropped in the first quarter and then built about 340 basis points of occupancy in that segment. And like I said, I feel better about this year. So it's fairly broad-based. We need better information for you guys relative to housing. What we do see is that there's more floor-covering-type demand, more demand for millwork, appliances and other housing-related activity, and that's probably growing 25%, 30% sort of quarter-to-quarter. So we are seeing that, and that does show more in the small tenant spaces. One final thing on aggregate demand and sort of our general sense of bullishness, I'll speak to the U.S. and there isn't any doubt that e-commerce is driving tons of demand. We're getting our share. But it's really -- it's focused on major population centers. It's focused on gateways. So there is -- there are winners and losers in this, and we think our portfolio is well positioned.

[Gary A. Anderson:]

So, Jamie, just a couple of things. I think on Europe and Asia, with respect to Europe, it's really about high utilization rates. The spaces that they're in are full. We don't have the same phenomenon of housing driving Europe today. In fact, the housing market -- it's really tough to get data on housing in Europe, but the data that we've been able to piece together in some of the larger markets is that from 2007, which was the peak, housing starts have dropped 55% and haven't recovered yet. That will be something that will be a driver in the future for Europe. In Japan, e-commerce is a big play. But the bigger and broader play, quite frankly, is reconfiguration, and that's going to happen for decades, so that's not a story that's going to go away. And in China, again it's about consumption

[Operator:]

Your next question comes from David Toti from Cantor Fitzgerald.

[David Toti:]

I just have a very quick question. Can you walk us through the 9% same-store expense growth that you posted in the quarter? What were some of the primary drivers there? And is it possibly related to some of the changes that you've instituted?

[Gary A. Anderson:]

Yes. It's Gary. Let me take a stab at that. First of all, I'd tell you that if you look at the comparable quarter Q1 2012, that was a very low expense quarter. We were actually down 6.6%, so it's tough to compare quarter to quarter, but let me try. The 9% change is really split into 2 pieces. You had the Americas and Europe, and it was basically half and half. For the Americas, we say this occasionally, but it really had to do with a light winter in '11 '12, so we didn't see much expense in the first quarter of '12. For Europe, it's a little bit more complicated story. You had the same sort of winter variants, light winter in Central and Eastern Europe. We had some repair and maintenance increases in northern and southern Europe, and there were some utility and property tax timing differences. Net-net-net, what I would tell you is that I wouldn't be concerned about operating expenses spiraling out-of-control. We've got them under control. Most of these are recoverable expenses. And in my view, again, I think we need to get a couple of quarters behind this, so we can get really good clean comparable quarter-to-quarter data.

[Operator:]

. Your next question comes from Michael Bilerman from Citi.

[Michael Bilerman:]

Hamid, you talked in your comments about sort of the rental growth upside that you laid out last September, the 20% to 25% upside in rents by 2016. And I think you made the comment on the call that you believe that you're still going to get it, but you're going to get it sooner. And the other thing that you put out at that Investor Day was, call it, $400 million of potential incremental NOI over $0.80, with the majority of that coming from this rent growth. And so just given the lease rollover schedule that you have, how should we start thinking about that 365 annualized number starting to hit bottom line FFO next year, the year after? How quickly will that come?

[Hamid R. Moghadam:]

Sure, Michael, that's a good question, and I think probably the single most important question in terms of what our earnings profile is going to look like in the next couple of years. The $400 million is a simple math of roughly 25% plus a little bit of occupancy gain, which from the point I made to comment, stabilization is about 2 to 3 points. It's a combination of 21%, 22% rental growth and a couple of points of occupancy gain, and 25% of $1.6 billion is $400 million, and that's how that math comes from. We actually did not project that in terms of what actually rolls over through the leases through 2016. I don't know. My guess would be 70% of it will rollover by 2016, and some of it will be anticipated in 2016 on our 2017 numbers. So it will be maybe 85%, 90% of it, but it's some fraction of it. It's not 100% of it. The other thing you've got going is that the leases in the interim that get marked to market are obviously going to have escalations on them. So those, while not affecting GAAP, those affect sort of our cash same-store kind of growth numbers. So that's really a ballpark estimate, but directionally, I think, if I'm going to make a guess, I would say we're probably 6 months earlier than what I told you 6 months ago. So feeling pretty good.

[Operator:]

Your next question comes from Craig Mailman from KeyBanc Capital.

[Craig Mailman:]

Jordan Sadler is on the line with me as well. Tom, I know you touched on it in the prepared remarks, the bump in expenses or the Private Capital business. Basically I know on Page 30 you laid out the pro forma edition there. But just looking -- are a lot of the expenses kind of front-loaded in that 99 and that 5.8 million flows right to the top line, or is there a little bit of margin erosion in the Private Capital business?

[Thomas S. Olinger:]

No, it's a great question. There is not. We're actually going to see improved margins in our Private Capital business. When you look at the Q1 number, it's seasonally a little high. That number will come down as we look forward into Q -- the rest of the year. And that -- the Private Capital expenses are going to go up a little bit as a result of NPR and that platform cost. And there are more assets under management in that business now compared to Q4. But Q1 was a little seasonally high. It will come back down, and you're going to see pretty significant margin improvement over the year in our Private Capital business.

[Operator:]

Your next question comes from Vance Edelson.

[Vance H. Edelson:]

Could you comment on property valuations in Europe? Are there any signs of improved sentiment there and higher valuations being applied? Or do you think that's going to have to wait for actual economic improvement, even though you're clearly outperforming based on the push toward upgraded logistics now?

[Gary A. Anderson:]

Yes. It's Gary. Look, I think that this is happening. We've seen of a very slight bit of compression over the course of the last quarter. But again I think that the Norges transaction that we did recently is a watershed event. And I think that you're going to see more capital coming into Europe. And as a result, I think you're going to see more compression. Valuations are lagging today, but I would expect over the course of the next 12 months you're going to see improvement there.

[Guy F. Jaquier:]

This is Guy. Just to add to that a little bit. In our funds in Europe, we've seen pretty much flat values for 7 quarters. We have not seen a recovery in value since the trough. If you look at last year, the entire logistics fund industry in Europe might have raised EUR 100 million of capital, virtually nothing given the scale of that market. Since the Norges transaction was announced, we have seen a significant pick up of real inquiries, real investors doing due diligence. And going back to Hamid's comments, we think the capital will flow through funds, ours and others, and will start to drive those values.

[Operator:]

Your next question comes from Brendan Maiorana from Wells Fargo.

[Brendan Maiorana:]

A question on the debt-to-EBITDA metric in the back of the supplemental, which, Tom, you mentioned in your prepared remarks. I'm wondering if you guys are now sort of looking at the balance sheet on that adjusted pro forma metric of 6.2x as opposed to the 7.5x, which is on the traditional metric and what that might mean for your target leverage and debt-to-EBITDA metrics, which I think on the traditional calculation are still 5x to 6x.

[Thomas S. Olinger:]

Brendan, it's Tom. Thanks for your question. There is absolutely no change in our long term leverage targets. We still want to get to 30%. We wanted to share the adjusted debt-to-EBITDA metric for the development business to make sure people really understand how that business impacts those metrics. And if you want to compare us to other companies who do not have a substantial development business, you have to adjust for that business to accurately reflect our financial position. So we think it's the right way to compare us to other companies, but absolutely no change in our long-term goals of leverage.

[Operator:]

Your next question comes from Ross Nussbaum from UBS.

[Ross T. Nussbaum:]

Can you talk a little bit about the goal you have for your U.S. dollar exposure? I think the commentary was you're up to 66% on Q1 transactions and the long-term goal was 80%. Generally speaking, can you just refresh us on what your time frame for that goal is? And at this point, are there any other, what I'll call, big moving pieces to get to that goal, or is it the basic blocking and tackling of the [indiscernible]

[Thomas S. Olinger:]

Ross, this is Tom. We'll see that goal -- I think we'll attain that goal over the next 2 years. The biggest movers of that were clearly the J-REIT transaction and the Norges transaction. As you know, we have the ability to sell down an incremental 30% in our Norges joint venture 2 years out. That will significantly impact this number. And we'll continue to contribute assets off of our balance sheet, development assets off our balance sheet in Japan into NPR. Now when you think about the other big dials that will turn this, it's really going to be on the debt side of the equation. We really moved most of the pieces on the asset side. So now it's on the debt side. You're going to see us move more of our long-term debt out of U.S. dollars into euro and yen to further naturally hedge our exposure. I think that'll take us over the balance of the next 2 years to get those pieces together, hopefully sooner.

[Operator:]

Your next question comes from George Auerbach from ISI Group.

[George D. Auerbach:]

Hey, Tom, could you help us maybe bridge the step down in revenues from the first quarter to the second quarter as you sort of fully move Norges and the J-REIT assets out of the revenue run rate?

[Thomas S. Olinger:]

Yes, so as a reminder, NPR happened on February 14, so it's in Q1's results for half a quarter. The Norges transaction happened on March 18, so less than 15 days in the quarter. When you look at those 2 transactions alone, that is about -- when you net -- after you net out the incremental fees we get from those transactions, it's about $27 million of NOI. So that is really what's driving that decline. And then there's also the timing impact of how we're deploying the capital. If you remember, we ended the quarter with $785 million in cash, and we're putting that to work in the second quarter. As you know, we redeemed $482 million of our preferred shares, and we also have substantially all of our balance sheet debt maturing by June 1 of this year. So we'll be able to redeploy a significant amount of the excess proceeds in the back half of the second quarter, but that really explains that dip. And going into the second half of the year, you're going to see core FFO grow back because we're going to see stabilizations from our development pipeline. As you know, we've been ramping up our development pipeline. That kicks in, you're going to see same-store NOI growth kick in. And also you're going to see the full impact of our deleveraging through lower interest expense, as well as the elimination of those preferred securities.

[Operator:]

Your next question comes from John Stewart.

[John Stewart:]

Tom, could you please give us the releasing spreads on a cash basis? And then, Hamid, you pointed out that the J-REIT has continued to trade well since the IPO. But, of course, the flip side is that there was some value left on the table. Could you please speak to the process, the execution and the trading since the IPO?

[Eugene F. Reilly:]

John, it's Gene. Let me take your first question on the cash rent change. We do not track that metric. And the reason we don't is, as you know, it's extremely volatile, and we believe other measure is more informative. So if we look at our quarterly GAAP rent change, in fact, it's in concessions and rent bumps and is a better gauge for comparing real apples-to-apples net effective rents on a quarterly basis. We think that's helpful. But if we really want to understand where our cash in place rents relative to the current market, you look at it just on a quarterly basis, you get a lot of noise. But as the rents have recovered globally, we think today overall the portfolio is currently under-rented by about 5%.

[Hamid R. Moghadam:]

So, John, this is Hamid. In Japan, the way an IPO works is that the buyer of the J-REIT, I cannot buy assets for more than appraised value, particularly when acquiring assets from a sponsor that's an affiliate. So no matter where the REIT market would have been, even if we were doing it today, it would have to transact at the same number. So really the pricing of the IPO only affects leverage and not the price of the sponsor. The more the price is, the lower the leverage is. So even if we had waited till today with the benefit of 20/20 hindsight and executed on the peak of the market, we wouldn't have gotten a dime more in proceeds. So that's the first point. The second point is that our range of pricing was JPY 500,000 to JPY 550,000. We priced at the top of that range, which was equivalent to the low 5% cap rate on the assets that were contributed. And that was a much more attractive cap rate than any of the analysts following us have in their NAV. And finally, I would say that in terms of exchange gains, notwithstanding the yen, if you will, weakening in the last 3 months from where we invested in those assets, we have several hundred million dollars of gain that you'll never see because they're foreign exchange gains. So in short, we're very pleased about the execution of the J-REIT, and we think it'll continue to be a great vehicle for growing values in Japan for us.

[Operator:]

Your next question comes from Michael Mueller from JPMorgan.

[Michael W. Mueller:]

I guess on the acquisition side, I was wondering if you could talk a little bit about the types of products you're looking at. Is it what you see in the pipeline as a predominantly stabilized assets? Is it stuff with lot of vacancy or just something in between?

[Michael S. Curless:]

This is Mike. We're certainly looking at a combination of acquisition opportunities, which range from primarily core. Most of our activity here has been -- 95% has been in the core markets. But a very important part of our business is the value-added acquisition. Part of our business where we have real success in identifying below or off market and very attractive returns that we can add our leasing machine to and create some real value. So I think we'll get combination of that as we look forward to the future.

[Operator:]

Your next question comes from Vincent Chao from Deutsche Bank.

[Vincent Chao:]

Just a quick question, just going back to sort of the development pipeline and the value creation there. Yes, I know you said the margins are pretty high right now. But just looking at the weighted average cap rate at stabilization estimated at 6 4, I know that ticked down just a tiny bit quarter-on-quarter. But just thinking about that relative to some of the cap rates that were discussed at the Investor Day, it just seems like it's a little bit high given the mix of assets we're talking about here in the pipeline being almost 50/50 Asia, U.S. And so I'm just wondering if you could provide some color on that, if that's just conservatism in there or if I'm not -- maybe I'm not interpreting that correctly.

[Thomas S. Olinger:]

Vince, this is Tom. To go back, we'd like you to think about what we've talked about margins to be from a long-term perspective. We've talked about build-to-suit margins being in the low-double digits. We've talked about spec being mid to high teens. And what you're seeing today is really those margins are reflective of the land bank that we're seeing today.

[Eugene F. Reilly:]

And let me just add one more thing, Vincent. You do have some mix of Brazil and Mexico probably in those numbers, which certainly in the case of Brazil dramatically affect it.

[Operator:]

Your next question comes from Michael Bilerman from Citi.

[Michael Bilerman:]

Yes, I just had a follow-up in terms of the G&A disclosure, Tom. I certainly appreciate it. I guess thinking about that you are in the development business the same way that you talk about the debt to EBITDA, you're deducting from here the $85 million of development G&A that you're capitalizing in the projects, but you're not including that as sort of this platform, but you are including the land and the development portfolio in your AUM. And actually it's a meaningful percentage. That's like 20 basis points in terms of G&A. I'm just curious why you don't think about the totality of the enterprise that you need because arguably you are in the development business. And if you are in the development business, you would have to either bring those people on or get rid of them, but then you wouldn't have the development AUM. So I'm just trying to think about how you are thinking about managing the enterprise in that way.

[Hamid R. Moghadam:]

So, Michael, you're absolutely right. We are in the development business and those are real people with real costs associated with them. And by all means you're welcome to add that to our G&A and look at it in the totality of our business. But that would be one way of looking at it. But it seems to me that it would be pretty inconsistent with looking at it without any of the gain or value creation coming out of the real estate -- out of the development business. So I guess the most conservative way of looking at it is to add 20 basis points to our overhead and continue to not count any value creation in the development business. The more modest way would be to attribute the proper overhead which, long term by the way, is a variable cost. Short term, it may not be a variable cost. And if we decided, for some reason, which we're not going to decide, just to be clear, to get out of the development business, we wouldn't forever have all these extra developers around. We would rightsize our organization. We could theoretically put all those people in a related entity off to the side and outsource to them as well and still show the same margins because the margins that we're showing, the 21%, doesn't include the cap overhead. If we were to add that to the margin, it would probably be 25%. So look, we're going to give you all the data. You can figure it out any way you want. In the long term, those costs are variable. In the short term, they're fixed. That's a real business. It produces real profits, and we're very excited to have it going forward. And full disclosure, you figure it out.

[Thomas S. Olinger:]

Hey, Michael, just one point of clarification. The $88 million annualizing the capitalized cost, those are not all development. About 40% of those costs relate to leasing. We'll clear that up so you can see the components of that going forward in the supplemental. And also to point out that we're not capping all of our development costs by any means. So sitting in our G&A are costs that support all of our businesses, and our back-office supports development just like it does our rent business, and those costs are not getting capitalized.

[Hamid R. Moghadam:]

Yes, it's just the direct cost of development, not the indirect cost of development so.

[Operator:]

Your next question comes from Michael Salinsky, RBC Capital.

[Michael J. Salinsky:]

Can you talk a little bit about the transaction [ph] activity plans for the balance of the year, how we should expect timing in terms of development starts? And also at the pipeline right now is about a 7.8% yield. Where would you expect additional starts to commence at over the balance of the year?

[Michael S. Curless:]

Well, in terms of our activity -- this is Mike. In terms of our activity in development starts, as Tom and Hamid mentioned we're certainly off to a good start this year at 300 million plus in the first quarter, which is typically a very light quarter. To give you a little contrast, this time last year we were at [indiscernible] 14% of the midpoint of our guidance range. We're already at 20% of the midpoint of the guidance range, and we have a handful of announcements, I think you've seen already, to put the balance of our development forecast in really good shape. We've got a handful -- announcements have been made and will be made soon to get the second quarter off to a real good start. And so, therefore, I think we're very bullish relative to our guidance on development activity going forward.

[Operator:]

Your next question comes from Brendan Maiorana from Wells Fargo.

[Brendan Maiorana:]

I had just 2 follow-ups. One, Tom, I think you mentioned initially in your prepared remarks that same-store guidance of GAAP basis plus 1.5% to plus 2.5% was unchanged, but I think you also stated that cash is likely to be higher. Wondering if the spread of roughly 100, 150 basis points that we saw in Q1, higher cash versus GAAP is likely to sustain throughout the rest of the year. And then secondly, on FFO guidance. I think you said the FX changes were a negative $0.03 a share. So should we sort of look at, from an operational perspective, that you're feeling $0.03 better at sort of the midpoint of your guidance, Q1 versus what you guys reported or what you guided to in February?

[Thomas S. Olinger:]

Okay, Brendan, on the same-store GAAP versus cash, if you look over the last really 5 quarters, the spread between GAAP and cash has ranged -- has averaged about 100 basis points. I think we'll see cash same-store outperform GAAP by about between 100, 150 basis points for the year. I think that's going to hold. Regarding the -- your FX question, and it did have a negative $0.03 impact on full year guidance. And you're right, we are seeing ops offset that, which is helping us keep our range the same.

[Operator:]

Your next question comes from Dave Rodgers from Robert W. Baird.

[David B. Rodgers:]

Yes, Hamid, with regard to the speculative development and construction that we've seen obviously increasing in the last couple of quarters with your excitement around the business as well, maybe can you talk about governors around the overall development pipeline kind of the sizing of the pipeline relative to the size of the company that you're thinking today, and then how that sizing might depend relative to the build-to-suit and speculative mix?

[Hamid R. Moghadam:]

Good question, Dave. So just to put the historic perspective, at the peak, I think the old Prologis was doing in the high 3s and the old AMB was doing in the low 1s of development. So combining those 2 platforms, even without considering that we have Brazil, which is an added market, it would have been 5 billion a year. We're not going to do $5 billion a year. We've been doing about $1.5 billion, inching up to $2 billion. As we laid out now 2, 3 years ago, we think it's a $2.5 billion a year type of number. To put a range on it, we only think it's $2 billion to $3 billion when it finally ramps up and it's stabilized. Not all of that will be our capital. Remember in Japan -- excuse me, in China and Brazil and Mexico, we're doing that with Private Capital. So roughly 60% of that will be our capital exposure. So our capital exposure on a run rate annual basis, call it, $2.5 billion times 60%, $1.5 billion on a bigger company compared to $5 billion before. So it's much more modest in the context of certainly history. In terms of -- and we continue to believe that the opportunity, profitable opportunity is about $2.5 billion a year. I mean, we could do $5 billion, but it wouldn't be profitable okay, and we're not going to do that. And I think it's going to be a year or 2 before we get to that level if the market continues in this direction. The build-to-suit percentage is -- has been unusually high. In the last year, it was 57%, et cetera, et cetera. Today, I think the run rate for build-to-suit is probably 25% to 30% for a company our size. But remember the spec deals that you talk about -- this is not putting up a 40 story spec office building somewhere. This is building the seventh building in a park where the other 6 buildings are full and we have visibility into what demand is. So I don't know what you call that, incremental development, whatever the name is, but purely it's not development in a spec or pioneering type of location. It's a [indiscernible] with an established base. And when you're 95% leased, which we're not there yet, but we'll get there, an incremental million square foot building on Prologis' 550 million square foot base is not really material. So I think we're very prudently managing risk in an integrated way across the company by not just the volume of development, but also by our capital exposure in development.

[Operator:]

Your next question comes from John Guinee from Stifel.

[John W. Guinee:]

Well, first wonderful job on the 10-quarter plan. Congratulations. Looking at Page 28, because that's an easy one to look at, Hamid, about a $30 billion total enterprise value, about $47 billion of AUM, does your 3-year plan basically have enough active asset recycling that the $30 billion and $47 billion number stay about the same? Or is this also a growth business in terms of those numbers, as well as square footage? And then the second question, which is really part of the first question is, you're creating a lot of value. It's not coming through the core FFO, but what's your thinking about the dividend and the ability to raise the dividend?

[Hamid R. Moghadam:]

Great question. So, again, good questions there. I think we are going to grow in terms of square footage in AUM, but not because that's a metric that we plan to, but because of the opportunities I see in front of us in terms of the business. And let me elaborate on that. First of all, we are cleaning up the portfolio pretty quickly in terms of getting out of other markets and the bottom of our regional markets. And as that process continues, there's less of it to sell. And I think we'll sell a couple billion a year for a little while, but I think on the other hand, we're developing, as I mentioned earlier, $2 billion, $2.5 billion a year, and we'll certainly have some acquisition activity on top of that. So I think net-net-net, AUM will grow, not a number that we plan around, but I think that's going to be the reality of the picture. What was your second question? Oh, dividend, dividend. I love dividend. I think the key run rate of the dividend will be matched to our key core FFO rate, over time. If -- our development gains and the way we look at it are not really accounting or realized gains. I mean what we do in terms of development and creating a margin does not necessarily mean that we're going to realize it in cash. It just means that we may put it in the operating portfolio. We may sell it to a third-party, or we may contribute it to one of our related platforms. So I think if we, all of a sudden, get gobs of cash because we sell it to a third party and we book a lot or we earn a lot of cash profits, maybe we'll do a special dividend at that time for that purpose if we can't manage it another way. I'm not a big fan of special dividends, but that's conceptually how we think about it. But really the long-term rate of the dividend needs to be matched to the core FFO earning power of the company.

[Thomas S. Olinger:]

John, I would add on the -- the other piece that the development gains really allow us to do is we're really -- we're redeploying that capital, all those profits, back into our development engine. It allows us to recycle that capital much more effectively, much more quickly. We don't have to go out in the market so those profits are really helping us fund our growing development business.

[Hamid R. Moghadam:]

And, John, let me also mention one other thing. As I said in the investor forum last September, I think eventually people will start giving us credit. I hope, by the way, never at 10x or 12x or whatever people were counting development profits in the good old days, but at the sensible 4x, 5x kind of a number in terms of the value that we're creating in that number, I may be wrong about that, but that's what I think. So I think there's some good news there.

[Operator:]

Your next question comes from Michael Salinsky from RBC Capital Markets.

[Michael J. Salinsky:]

When you talked about the effect of single-family a couple of quarters back, you talked about the small block space in the portfolio. Can you give us an update what -- how much leasing you're -- the occupancy in that portfolio, and how that's tracked over the last couple of quarters? Have you seen a pick-up in single-family housing?

[Hamid R. Moghadam:]

Mike, I'll tell you what, Gene already answered that question a little earlier. You may not have been on the call. So instead of repeating that, why don't you just call Gene, and he'll take you through it, if you don't mind.

[Operator:]

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

[James C. Feldman:]

It's Jamie again. Just following up on what you're saying about build-to-suit and just new supply in general, is there something going on in this cycle that there is more of a demand for build-to-suit rather than spec? And I'm just thinking maybe it's like e-commerce related or supply chain redesign, where these companies want very specific -- have very specific requirements. Or is there something else that's driving the fact that we've seen so much more build-to-suit than usual at this point?

[Hamid R. Moghadam:]

I think the buildings are getting bigger for e-commerce and there are fewer private developers. The private developing machine is really constrained right now because of financing. And, Jamie, you would know that obviously. So it's tough for these private guys to get a lot of financing, million-square-foot buildings even in out-of-the-way places are $50, $60 a foot, so those are big-ticket items. I don't think it's because the buildings are particularly specialized. I mean the shelves and configurations are pretty flexible. What people put inside of them in terms of conveyor systems and the like in some cases can be elaborate, but that's at the tenant's cost and it's removable. In fact, actually, if you go look inside a lot of these fulfillment centers that are these big buildings, you'd be really surprised to see how low tech some of them are with boxes sitting around on the floor and actually the building is not that crazily, heavily utilized because the whole distribution is set up around parcels as opposed to pallets and all that. So nothing special about the buildings. Buildings are getting bigger, and the private machinery for building spec is constrained because you can't get 100% financing. Mike, do you have more to say about that?

[Michael S. Curless:]

Yes, there's more expectations I think with these customers to identify what we like to consider the safe choice, folks that don't have any financing contingencies have a long track record with building high-quality buildings, and these requirements are gravitating, as you've heard before, to larger or global markets. And those 3 facts have contributed to, we think, a very substantial and high closure rate for us. And then you mix in the dearth of supply of large spaces around the country, then they really got nowhere else to go. And it's all playing very well into our hands right now.

[Operator:]

Your next question comes from Michael Bilerman.

[Michael Bilerman:]

I just had a quick question. Tom, just on the debt to EBITDA, the 7.5 GAAP number, the debt is reflective of all the sales that you did because it's an end-of-quarter number. Have you pro forma the EBITDA down for the NOI that's effectively going out from the sales?

[Thomas S. Olinger:]

Yes, we have. When I talked earlier about the drop in NOI over quarter 1 to quarter 2 of the run rate, we've adjusted that down. It's about $27 million, I think. It's footnoted. I think it's on Page 9 of the supplemental.

[Hamid R. Moghadam:]

Okay, Michael, you get the last word. Thank you, everyone, for your interest, and we look forward to talking to you next quarter if not sooner. Bye-bye.

[Operator:]

Thank you, everyone. This concludes today's conference call. You may now disconnect.