Prologis, Inc.
Q3 2015 Earnings Call Transcript

Published: 20 Oct 2015

[Operator:]

Good afternoon. My name is Suzanne, and I will be your conference operator today. At this time, I’d like to welcome everyone to the Prologis Third Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Ms. Tracy Ward, Senior Vice President of Investor Relations, you may begin your conference.

[Tracy Ward:]

Thanks, Suzanne, and good morning, everyone. Welcome to our third quarter 2015 conference call. The supplemental document is available on our website at prologis.com under Investor Relations. This morning, we’ll hear from Hamid Moghadam, our Chairman and CEO, who will comment on the company’s strategy and the market environment; and then from Tom Olinger, our CFO, who’ll cover results and guidance. Also joining us for today’s call are Gary Anderson, Mike Curless, Ed Nekritz, Gene Reilly, and Diana Scott. Before we begin our prepared remarks, I’d like to state that this conference call will contain forward-looking statements under federal securities laws. These statements are based on current expectations, estimates and projections about the market and the industry in which Prologis operates as well as management’s beliefs and assumptions. Forward-looking statements are not guarantees of performance, and actual operating results may be affected by a variety of factors. For a list of those factors, please refer to the forward-looking statement notice in our 10-K or SEC filings. Additionally, our third quarter earnings press release and supplemental do contain financial measures, such as FFO and EBITDA that are non-GAAP measures and in accordance with Reg G, we have provided a reconciliation to those measures. With that, I’ll turn the call over to Hamid, and we’ll get started.

[Hamid Moghadam:]

Thanks, Tracy, and good morning, everyone. Welcome to our third quarter call. Let me start with some brief introductory comments, and I’ll turn it over to Tom for more details on the quarter. In most markets, business just keeps getting better. The operating environment is stronger than I’ve ever witnessed in the U.S. In Europe, rents are flat and occupancies are trending up, cap rates continue to compress. Let me call out Paris as the only major submarket in Europe that I can think off. In Japan, we have a mixed picture. Development is up 26%, but surprisingly sentiment is strong, and there’s quite a bit of preleasing, rents remain strong. China is slowing, but less than the media headline suggest. In fact, the business relating to this domestic consumption is very strong, and it’s only the export locations that are experiencing some softness. In Brazil, demand for industrial real estate is holding up despite a weak overall economy. Overall, I would summarize demand as being ahead of our expectations and supply below. We’re seeing bidding words between customers for space something we hadn’t seen in many, many years. As the difference between in-place and market rents widened, there is a multiyear driver of NOI growth that’s created, which is almost independent of market rent growth assumptions from here on now. All of these factors have led to very strong financial results for the quarter and the year so far. I want to address the issue of supply, because I get a lot of questions on this. We just came from ULI in San Francisco, and I must say that the memories of the great recession are quite fresh. The toll that it took on real estate will not be forgotten soon. Nobody seems to want to go there again, and all of us are looking for sustained long-term growth in rents. While it’s the best of times in our industry, our takeaway is that the tone is very conservative in our new development. Customers on the other hand are pressing us for more space to fulfill their needs. We get hurt this over and over again at our recent Customer Advisory Meeting in New York. We said we’d be vigilant on supply, and in that vein, I’d like to call out Houston, as a market that has the potential for getting overbuilt. There are 7 million feet of construction coming online, mostly in the port market and 3 million square feet of that is spec. So that’s a market we are watching very carefully. Globally, we’re cautious with our development starts, particularly on the spec side, because supply and demand are not closer to equilibrium. On the other hand, our built to suit volume has moved up from the low-30% range of total starts in 2014 to the low-40% in 2015, and we’ve had some major wins with companies, such as Menlo Logistics and BMW. Bottom line, there’s quite a bit of discipline around spec development, and our focus remains on profitability and markets. Let me talk a bit about the investment sales market. We’re still living in an era of wallet capital being interested in real estate. Demand is robust for high quality well located industrial assets. We’re confident we’ll be able to meet our disposition goals, the majority of that work is well underway. In the long-term, our emphasis is going to shift to calling the portfolio when appropriate. Most of the heavy lifting is behind us. Let me give you an update on KTR and its impact on our overall operations. The KTR portfolio is exceeding our expectations. We’re leasing at the higher than expected rent and on pace with our projections. While bigger isn’t always better, the benefits of scale are becoming increasingly clear. We’ve grown our market-leading positions around the world in many locations. But perhaps the most important thing is that, we’re driving G&A down. The transaction has allowed us to reduce our G&A as a percent of assets under management from 65 basis points last year to about 55 basis points this year. With that, let me turn it over to Tom, for the details on the quarter.

[Thomas Olinger:]

Thanks, Hamid. Operating results and cash flow growth remains strong and we’re generating significant value creation through development stabilizations and VAC dispositions. I’ll start with our Q3 results. We generated core FFO of $0.58 a share, up 21% over the third quarter of last year. Occupancy, excluding the KTR portfolio was 96.2%, up 60 basis points sequentially. This is essentially at an all-time high. The team is making great progress on the KTR portfolio, which was over 93% leased and had releasing spreads of 20%, exceeding both our underwriting and the remainder of our U.S. portfolio. Our share of GAAP rent change was 12%, driven by the U.S. at 16.4%. GAAP same-store NOI continue to improve as our share increased to 6.2% in the quarter, again, driven by the U.S. at 8%. In the third quarter, the amortization of lease intangibles from the merger, which has been negatively impacting GAAP NOI since that time finally fully burned off. This has had a positive impact of about 100 basis points on GAAP same-store for the quarter. We expect the impact for the year on same-store to be about 50 basis points from this burn off of the intangible asset consistent with what we outlined at our investor event last fall. Regarding cash same-store NOI growth, we would expect it to converge with GAAP during the back-half of next year. Moving to capital activity, year-to-date, our share of dispositions and contributions totaled $1.7 billion at a 4.8% stabilized cap rate, generating over $210 million of realized development gains and $165 million of value creation from VACs. Pricing on our third quarter activity was equally strong at 4.9%. The profitability of our overall development program continues to be outstanding. Year-to-date, we’ve stabilized $1.4 billion of developments at a 34% margin, generating about $460 million of NAV accretion, or about $0.86 per share. Let’s switch to 2015 guidance. I’ll highlight only the key points here, so for a complete detail, please see page 8 of our supplemental. We’re increasing the bottom end of our year-end occupancy guidance with the range now between 96% and 96.5%. Our share of GAAP same-store NOI growth for the year remains unchanged at between 5% and 5.5%. We now expect net G&A to come in lower for the year, ranging between $235 million and $240 million, a decrease of 4% at the midpoint over last year. At the same time, assets under management have grown by 13%. For strategic capital, we continue to expect a net promote from our PELP venture in the fourth quarter of about $0.04 a share. We are nearing the range of our development starts to between – to be between $2.5 billion and $2.6 billion. The slight decline is timing related as some build to suit activity moved to Q1. But having said that and as Hamid mentioned, we are being diligent with speculative starts, so don’t be surprised the total starts next year are flat or slightly down. We’re focused on profitability, not trying to reach a volume number. We’re seeing the profitability of our developments coming through realized gains, which we now expect to be between $300 million and $325 million this year. As we discussed last quarter, we had $1.3 billion of short-term debt related to our acquisition of KTR. This consisted of $1 billion term loan during 2017, and $300 million drawn on our line of credit. We continue to plan to repay the short-term debt with proceeds from dispositions and contributions. In the third quarter, we reduced our line balance by $232 million leaving less than $1.1 billion of this to be repaid. The reduction is consistent with our expectations as a majority of disposition and proceeds from the third quarter were used to fund planned development spend and acquisitions. We expect to generate about $500 million of proceeds from our net deployment activity in the fourth quarter. You can get there using our fourth quarter guidance factoring in the OP units issued in connection with the industrial portion of the Morris transaction, as well as using development spend. We’ll use the net proceeds from the fourth quarter to further reduce our short-term debt for a total reduction of about $750 million by year-end. As a result, leverage on a gross book basis and debt to EBITDA should be about 38% and seven times respectively by year-end. This will leave us with approximately $550 million of short-term financing, which we expect to repay by the middle of next year. We’re very confident that we’ll complete our planned fourth quarter capital recycling. As Hamid mentioned, buyer interest from our dispositions is strong and diverse. For contributions, our ventures are well-capitalized, and we are far along in the process of completing property appraisals and fund approvals. As we mentioned last quarter, we have substantial embedded capital in our ventures, given our ownership as well above our long-term target of 20%. The ability to reduce our interest to this level provides us with significant flexibility and optionality to fund our future capital needs. Putting our guidance together, we’re maintaining the midpoint and narrowing our 2015 core FFO range to between $2.19 and $2.21 per share. This represents 17% year-over-year growth, or an increase of $0.32 at the midpoint. In closing, we had exceptionally strong operating results, cash flow growth and significant value creation. Looking forward, we have substantial liquidity and a high degree of confidence, as well as optionality in our capital recycling plan. With that, I’ll turn it over to the operator for questions.

[Operator:]

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

[Brendan Maiorana:]

Thanks. Good morning. I wanted to ask a little bit about rent spreads. They were about flattish with where they’d been in the past couple of quarters, and it look like your scheduled expiring rents moved up a little bit. So with the change in the expiring rents that just a mix issue, or were you able to pull forward some of those low expiring rents this quarter, and how should we kind of think about the change in rents going forward from here?

[Eugene Reilly:]

Yes, Brendan, it’s Gene, let me take that. We’re always pulling forward rents, so it’s difficult to look at a schedule and sort of predict what’s necessarily going to happen in the next quarter. But let me draw your attention a couple of changes quarter-to-quarter that are worth noting. We had a heavy volume of leases in the Northwest and Southwest. In the U.S., we had 40% of the leases rolling, wherein those regions, those are the highest rent change regions. In this quarter, it’s just 22%, and virtually all of that was taken up by the East, which actually has the lowest. So you are going to see this sort of quarterly volatility just based on the mix. But to answer the – your last question or last segment of it, if you look out into next year, just take a look at page 22, what we’re rolling next year and frankly, what we’re rolling in 2016? Now that mix won’t tie exactly to what we actually lease next year, but it’s a pretty good proxy, the – and the comps look really, really good going forward. So bottom line is that the trajectory is going to look just like it has. It will have an upward slope to it, I think it’s going to have an upward slope to it going into next year.

[Operator:]

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

[Craig Mailman:]

Hey, guys. Tom, just on the high-end of guidance, just curious what really brought that down, because when you look at some of the operating metrics year-end occupancy trended a little bit higher, you had the $5 million reduction in G&A at the high point and really kind of an increase in net investment activity, given some of the slowdown in dispositions relative to what you guys have thought about before. So just maybe clarify that and just one other quick one on, Hamid, your comments about feeling good about the disposition pipeline here for the fourth quarter. Could you maybe just give us an update on what kind of volume you guys have under contract grow in line and maybe expected timing on that $1.3 billion?

[Thomas Olinger:]

Hey, Craig, it’s Tom. I’ll take the – both of those questions. On the guidance change, really note, the only reason why the top end is down slightly as this deployment mix. Actually, what we’ve sold to-date has been right on time, actually even a little bit ahead of what we talked about on an R share basis, so what you’re seeing in the fourth quarter is purely timing around deployment. Just regarding a similar color on our plan contribution disposition activity in the fourth quarter, our share of the contribution disposition activity is $1.3 billion, that’s $900 million of dispositions and $400 million of contributions. Taking the contributions first, as I mentioned earlier, the funds have adequate capital. They’re extremely well-capitalized, low leveraged. We’re very far long in getting the appraisals done and standard approvals done. And these contributions have been in their deployment plans all year. So this is what we’ve been planning for, and we feel very good about that happening by the end of the year. On the disposition side, as Hamid mentioned of our pools very deep, pricing is meeting and in some cases even beating our expectations. If you look at the contributions plus the dispositions where we’ve already identified a buyer, that represents about 80% of our Q4 activity. So as Hamid said, we’re well on our way of knocking this out by the end of the year, and so we feel good about our progress to-date and what we’re getting done right now.

[Hamid Moghadam:]

Yes, and the other 20% by the way is in the market or shortly be in the market. So just to put this in context, the kind of disposition volume that we’ve done in prior years post merger is orders of magnitude larger than this. So we’re not losing a lot of sleep on the ability to execute here.

[Operator:]

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

[Vincent Chao:]

Hey, good morning, everyone or good afternoon. Can you just talk about, I think I heard KTR renewal spreads about 20%, so better than the overall portfolio. Can you just remind us where you’re at on the leasing side, I think, you was 92% last quarter, and is that part of the uplift in the occupancy guidance here as just KTR leasing up faster as well?

[Eugene Reilly:]

Yes, it’s Gene, let me take that. We’re 93% leased to this point, so it’s up marginally. It’s not, I mean, given the size of that portfolio, it’s not going to have a meaningful impact on the overall numbers. So but we’re on track. My guess is, we’re going to beat our estimate. When we announced this deal that within a year, this portfolio would basically be – have this similar occupancy as the overall portfolio, so we’re on track for that. In terms of the spreads, you’ve got to be a little bit careful, a quarter is a quarter and those will bounce around a lot. But deal by deal, we are beating the underwriting so far, so that’s good news.

[Operator:]

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

[Emmanuel Korchman:]

Hey, guys, good morning. Maybe as you look at your portfolio being near peak occupancy levels, is there anything changing the way that your approaching deals or approaching relationships with customers or anything else that’s changing the business?

[Thomas Olinger:]

Yes. So the last time we were in the 96% plus range was briefly in 2008, but really you got to go back to 1999 before you see those kinds of occupancy levels. We try to balance occupancy with rent, so we definitely push harder on rent when occupancy levels are at this level, particularly in the U.S. In Europe, we’re not obviously pushing quite as hard on rents. Rents are up slightly, but our pricing power is not as strong as it is in the U.S. clearly. The other things that we’re doing with these – this leases is that, we really focus on term and credit, so this enables us at this point in the cycle to lock in rates and escalations and good credit all at the same time. And this is – those are the variables we play with at different points in the cycle.

[Operator:]

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

[Ki Bin Kim:]

Thank you. Could you just comment on how to praise – cap rates are looking like in Europe? What’s your kind of current view on when those cap rates reach a 6% or sub-6% level that would maybe accelerate some of your European asset sales? And the second question, any commentary on directional fund flows into your funds right now?

[Gary Anderson:]

Yes. So, Ki Bin, it’s Gary. Let me take that. So for the quarter core cap rates in Europe are down about 20 basis points. The secondary market has basically been flat, they haven’t moved much. So overall you’re sub-6 today. You’re somewhere probably between 5.75% and 6% in our fund, so certainly an improvement. We’re obviously looking at dispositions in Europe, where they make sense, and where we feel like we’re getting value, and we’ll execute on those as and when they come. With respect to fund flow, we actually have a pretty deep queue in our open-ended fund today. And I’d say that even that is underestimated, there’s a shadow queue behind it. So I think we’re in pretty good shape in Europe today.

[Hamid Moghadam:]

Yes. Let me just add to that. I think the reason we’re not taking more capital and adding to the queue is that, we want to get people’s money invested in a reasonable periods of time, and we don’t want to take on capital that we don’t see opportunities for in terms of investing in the marketplace. Also, the sub-6 cap rates that we’re seeing, obviously the UK is really low. I mean, UK many instances is in the 5, and in some cases we’ve actually seen the 4 in front of some of the cap rates in London and Southeast type markets. But the Continent, even the worst markets on the Continent are now in the low to mid-sixes. So the Continent alone would be also under 6 on a blended basis. Cap rates in Europe, I think, when we talked to you a couple of years ago when there was a lot of concern around CapEx in Europe, our estimate was that, they were going to compress about 1.5%, 150 basis points. And at that time, cap rates were about 8%. In fact, that’s what we recapitalized taper at with the largest transaction. I got to tell you, we were conservative. Cap rates in Europe have declined already by about 200 basis points from those days, and we just had a very recent conversation with our team about this. The feeling is that, there’s probably another 25 to 50 basis points of cap rate compression remaining, so that our old 150 may end up being 250 basis points. We’re not there quite yet, but we already passed the 150.

[Operator:]

Your next question comes from the line of Ross Nussbaum of UBS. Your line is open.

[Ross Nussbaum:]

Hey, guys. Good morning out there. You touched briefly on – some thoughts on development starts for next year, saying, don’t be surprised, if they could be flat to down. I was hoping you could expand on that a little bit, because I think one of the potential concerns out there is the development start have ramped for the company annually into this cycle. And at some point, the market is probably going to look to see that number back down. So can you talk about how you think not just about 2016, but how you think about capital allocation and risk over the next couple of years with respect to those development starts?

[Hamid Moghadam:]

Ross, this is Hamid. Let me take this since I was here during the entire cycle what we talked about development volumes. Going back to actually right after the crisis, I think, in one of our analyst days in New York, we talked about across the cycle development volume is being between $2 billion and $3 billion. And that was a time, I think, where we were doing $300 million or $400 million of development in the really low point to the cycle. And I think the market had a hard time getting its head around sort of $2 billion to $3 billion type numbers. We said the average across cycle would be about $2.5 billion. Well, we’ve now slightly exceeded the $2.5 billion. As I mentioned in my prepared remarks, we’re really cautious about starting spec. And I think the entire market is really cautious about starting spec. That’s why our built to suit ratios are up from the low-30s to the low-40s. Look, we’re getting 30% plus margin. This is not because we’re geniuses, it’s because we have some cheap land and we’re getting cap rate compression in some of these exits. And those two factors are contributing to strong margins. But every time we look at a spec development, we really look at it against the alternative of selling the land to that market. In fact, we analyze it with land being price of market, because that would be the other way for us to – our best value out of the portfolio. And so we’re much more interested in getting strong margins out of our development pipeline than driving the volume by a couple of hundred million dollars. You should not read too much about – my commentary about development volume. The point I wanted to make is that, we are not building to some magical volume number. We don’t have internal goals that we need to meet in that regard. We’ll build as much or as little as we think we can prudently lease and realize margins on.

[Operator:]

Your next question comes from the line of Dave Rodgers of Baird. Your line is open.

[Dave B. Rodgers:]

Yes good morning out there and maybe this question is either for Hamid or Gene and probably for Tim mostly the U.S. but with occupancy guidance of 96 and 96.5 the spread that we’ve seen retention, kind of pushing 90%. Do you think you’re pushing rents harder than as you think there is a greater ability to do so clearly the spread should get better based upon your comments earlier, but just kind of curious about hey cautious or more aggressive tone regarding taking retention down maybe pushing occupancy down a little bit to get better rent growth?

[Hamid Moghadam:]

Hey, Dave, that’s a really good question and I want to hear and I want to hear, Gene, please go ahead.

[Eugene Reilly:]

It is great question and the answer the honest answer is no. I don’t think we’re pushing rents hard enough we’re pushing them harder than they’ve ever been pushed in the history of industrial real estate I would point out and I feel great about our spreads maybe, compared to competitors or the rest of the market. But it becomes a very psychological game at this point and I don’t think we would look at let’s strategically take down retention for example or get that nuance, but I can tell you in our leasing discussions it’s a different environment and we ask our teams different questions. One of the questions we’ve added is tell us about the deals you said no to, tell us about the leases that you backed away from, and told the customer we’re serious about this rent and if you need to go to another building we understand and I’m serious about that, so we’re having those discussions we’re going to follow those transaction see what happens to those spaces it’s a sort of a new world here I mean I’ve been doing this for 30 years, so I’ve seen cycles and we have had very strong cycles in the past, but nothing even approaching this. And next year I wouldn’t be surprised if eight or nine U.S. markets have a three handle on actual vacancy probably three or four already do that’s just uncharted territory so your question is a very good one I can’t give you a scientific answer, but we’re really focused on it.

[Operator:]

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

[Jamie Feldman:]

Great. Thank you. I’m here with [indiscernible] as well. So looking at the third quarter development starts it looks like it was pretty light in the U.S. overweight in Europe and lighter in Asia. Can you talk about the composition of what you think you might start in the fourth quarter the $1 billion of starts and then as we think about the next year being flat to down what’s the U.S. composition. And then in addition just kind of thinking about what are these numbers tell us about what’s to come and how you’re thinking about the market?

[Michael Curless:]

Jaime, this is Mike Curless. With respect to the Q3 volume just natural things going on there with some build to suits that are been moved into the fourth quarter nothing unusual into the third quarter we have a heavy set of volume plan for the Q4, which is very typical for our company we’ve done that for the last several years. And if you look at the overall volume this year it’s going to be up over call it 20% at least over last year we’ve increased our build to suit percentage to well over 40% all, while keeping the margins around 20%, so we as a company feel really good about the quantity and the quality of this work to Tom’s point earlier. And as we look into the next year we would expect the build to suit volume to continue to increase and we have volume that will be more measured, compared to this year.

[Operator:]

Your next question comes from the line of Brad Burke of Goldman Sachs. Your line is open.

[Brad Burke:]

Everyone just a quick one on FX, I realize you are hedged for the remainder of this year and you’ve also done a lot to hedge your FX exposure on the debt side. But can you give us a sense of what kind of FX impact we should expect as those hedges start to roll off the timing and the magnitude of any headwind they might have?

[Thomas Olinger:]

Hey, Brad, it’s Tom. So on the earnings side, we actually hedge out on the earnings side 6 to 8 quarters ahead of where we are. So we’re always hedging and we walk ourselves into that hedging we don’t do 100% of Q3 of 2017 at this point we’re probably we’re almost fully hedged for our estimated earnings in 2016 and we probably have hedged for estimated earnings in 2017 and those are just simple straightforward contracts that we do. From an earnings perspective from Q from 2015 to 2016 the earnings impact from where we walked in rates is probably $0.02 to $0.03 of an earnings drag on 2016. That being said, I – we still feel good about where 2016 earnings will come in, we’ll give you guidance next quarter on that, but we feel really good about maintaining strong growth into 2016. So it’s baked into our numbers and we feel good about our growth prospects.

[Operator:]

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

[John Guinee:]

Great. Thank you. Just a couple of comments, which will lead into a question. It appears that looking at the fund flows out there that the incremental investor in the REIT space might be a generalist as opposed to the rededicated crowd and as well, we can manage FFO versus the degrees of leverage and whether your borrow short or borrow along. So, Tom or Hamid, when you’re looking at managing your valuation metrics, NAV versus FFO, how you’re thinking about managing those valuation metrics vis-à-vis the incremental buyer out there of your shares?

[Hamid Moghadam:]

John, we manage our business for cash flow in our pocket and ultimately dividends to our investors and the growth for that, because I don’t think dedicated or non-dedicated investor have different appetite and interest in making money. I think, they’ll want to make money, and at the end of day it’s cash in their pocket and the growth in that cash profile. So we are being real estate people, so by definition we’re more NAV focused, but those two things are not unrelated. I think the issue that I think you brought up last quarter and I think your question implies this quarter is that, has there been a lot of NAV creation in a constant cap rate environment? Well, that would not be an appropriate way to look at our company, because we sold the bottom 20% of our portfolio. We sold our highest cap rate assets, and we’ve acquired in our target market presumably at the lowest cap rates and the best growth potential. So, people can do any kind of analysis they want. But at the end of the day, I think, what you should focus on, what I’m focused on is dividends paid and the growth rate in those dividends over time.

[Operator:]

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

[Vance Edelson:]

Thanks. Hamid, you mentioned export oriented softness in China. Are you seeing the same dynamic in the U.S., in other words, what effect is slower global economic growth having on your U.S. domestic business when it comes to your more export oriented tenants? Do you hear anything about sluggishness in their business that might affect leasing demand?

[Hamid Moghadam:]

So exports have never been a really big driver of demand in the U.S. And a lot of the containers that go out of the U.S. are actually going out empty these days because of the strong dollar. Imports are much more significant in terms of driving demand. And the weakness in the ports – port markets in China compared to the consumption type buildings is mostly because of very imports of raw material and parts and things of that nature, none necessarily to our exports, because exports generate a warehouse demand not at the port and not at the market that we invest in, they generate that demand near the factory, where the goods are produced on the export side. So exports are usually not a big deal in terms of industrial demand. Now, I’d like to do one thing before we take the next question. I think, Jamie, asked about the mix of our development business. And, Mike, skipped over that part of the answer. Based on our current projections and this will change the Americas in the fourth quarter remainder of the year, we think about 40% of our business will be in the Americas, 30% in Europe, and 30% in Asia. For 2016, it will be about a third in the Americas, a quarter in Europe, and about 40% in Asia. And the Asian numbers are probably more driven by Japan and China; Japan will be bigger. And we have – all those projects identified and it’s pretty well known what we’re going to build next year, because we have the land and they’re designed and they’re ready to go. So take that for whatever it’s worth, I think it’s going to be closer to those kinds of numbers.

[Operator:]

Your next question comes from the line of Michael Miller of JPMorgan. Your line is open.

[Michael Miller:]

Core opportunities for promote in 2016, so wondering if you could talk about the potential magnitude of those compared to 2015?

[Thomas Olinger:]

It is Tom. So, again, we’ll give guidance in the next quarter, so I won’t get specific, but if you look at where we’re promoting next year we’ve got our two open-ended funds in Europe PEPF II and PTELF those last were eligible for promote in 2013 they did not promote at the time they’re up again and I think the second or third quarter. I think third quarter of next year and think about what cap rates – Hamid’s comments about what cap rates have done over that period of time of pretty meaningful drop and the promote is going to be calculated as a point-to-point valuation return, so…

[Michael Curless:]

I’m Mike, they’re going to be lot higher, but please don’t get excited, because I think this business promotes are the last bit of residual that remains after you get the capital back and the preferred return, so a little bit of movement on the terminal cap rate or on what happens can really move around promotes in a big way based on what we see to-date they’re going to be quite significant. But in terms of the way you should think about them in valuing the business my sense is that across the cycle those promotes net to the company are about 15% to 20% about this under management on a fairly regular basis once you average it out over time take this point I’m saying I wish you would...

[Operator:]

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

[Eric Frankel:]

Thank you. Two quick questions. First it seems like you’ve sold a lot more impaired land this quarter, so I was hoping you can comment on that and who the buyers were at that land. And second I noticed that your free rent balance went up pretty significantly from the second quarter to third quarter so any color would be appreciated thank you.

[Thomas Olinger:]

Hey it’s Tom, I’ll take the free rent one first it’s twofold. First is remember I talked about in my prepared remarks the burn off of that lease intangible from the merger that was a negative item that’s burning all that fully burned off in Q3 for the first time, so that’s part of it. And then the second piece would just be we’ve got a bigger portfolio right, so think about adding KTR and the like and the volume of leasing activity we’re doing that would be the – those would be the drivers.

[Hamid Moghadam:]

Yes, I can remember. KTR was disproportionate, because KTR had more vacancy and therefore more space to lease than the average of our portfolio.

[Michael Curless:]

And Eric with respect to this is Mike, with respect to land sales we’ve an active quarter and the primary buyers of our non-strategic land have been users and some developers for building product that we don’t tend to build.

[Operator:]

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

[Thomas Lesnick:]

Hi, thanks for taking my questions. I just want to talk about the potential for going vertical for a second where rents are right now and into locations in San Fran and Seattle how close are those rents to justifying going vertical and what is that potential repositioning opportunity represent for those markets for Prologis as a whole?

[Hamid Moghadam:]

So, Tom, did you actually think into our customer advisory meeting guy at New York and, because this is the exactly the two markets that we talk to customers around we went as far as actually taking design specific designs and getting their input on it on some very specific sites and based on that we tweak some of our design ideas, so I think we you’re going to see us going probably two-story anyway maybe three in San Francisco on a couple of places as we fine-tune this product, we’re going to experiment with it we’re not going to all of a sudden go nuts with it, but it’s certainly something that I think the market is ready for. Let me also mention another way that we go vertical on our site that that you may not normally think of and that is in the last year we sold about over $500 million of real estate that $0.5 billion of real estate to users and companies well-known technology companies with hundreds of billions of dollars of market cap you can figure out who they are and they’re going to go vertical on those properties, because they’re going to knock down our beautiful one-story warehouses and build corporate campuses or are ready on them to house their employees. So I think when you own infill real estate as we said many times good things happen to it than I think we’re beginning to see those good things happening to some of our properties.

[Operator:]

[Operator Instructions] Your next question comes from the line of Brendan Maiorana of Wells Fargo. Your line is open.

[Brendan Maiorana:]

Thanks, Tom. I had a follow up. So you mentioned by end of the year, I think 38% leverage is where you expect to get to seven times debt to EBITDA. And I think you said you’ve got $550 million of short-term refinancing that would be left at year-end that you expect to get done by the middle of 2016. From a leverage perspective, how should we think about net dispositions and the pace of dispositions and contributions in 2016 to get to your leverage targets?

[Thomas Olinger:]

Well, I think, so two things. So when we’re looking going forward, we’re thinking about not only funding this remaining $550 million into next year, but we also plan to sell fund all our deployment activity, so starts as well. So when you think about, I mean, rough, I will give you some rough numbers just our share. So think about the $550 million we have to spend. And then if you think about how we recycle capital with our development program, right? We build – we contribute in the funds. We hold what’s on the U.S. on our balance sheet. We need to raise about $600 million, maybe $650 million a year to kind of keep that cycle going. So if you think about the $550 million plus $650 million, that’s $1.2 billion. Now acquisitions are going to be what acquisitions are and we’ll fund those most likely through our joint ventures whatever they are. So if you kind of think about the level of our share proceeds, we need to do it in knockout development next year, as well as the $550 million would be in that range.

[Hamid Moghadam:]

Yes, and I think the best way for you to monitor that is to look at our land balance, and it will be lumpy, it will bounce around, because we can’t find everything perfectly. But I think it would be a very low-level balance on our line moving around quarter-to-quarter.

[Gary Anderson:]

Brendan, I should add, I didn’t answer your question about just trending up where our leverage and debt to EBITDA will go. I think, if we look at this plan all encompassing this self-fund next year. I think by the end of next year, you’re going to see us back in the mid-30s LTV wise. Again, this is on a book basis, not a market cap. So we’re being consistent here. And I think debt to EBITDA is going to – without any gains, is going to get into the low-6 range, I think that’s where we’ll be.

[Operator:]

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

[Emmanuel Korchman:]

Hey, Tom. In the past, I think you’ve given releasing spreads for the other regions outside the U.S. Could you provide those and could you also give us some color on same-store NOI growth U.S. versus Asia and Europe?

[Thomas Olinger:]

Okay. I’ll start with the same-store NOI growth. Basically, you saw in the U.S., we were on a GAAP basis 8%. We were flat to maybe up 1% in Europe, and we were up, call it, 5% give or take blended Asia. So when you put that altogether and you think about our share, that’s how you get to 6.2% our share same-store. An easy way to think about how to calculate our share is roughly about 80% of our NOI comes from the Americas, 15% from Europe, and 5% from Asia. So that’s how – so roughly weight the different parameters. As far as releasing spreads, again, we talked about the U.S. leading the way. We were at over 16%. I think in Asia, again, releasing spreads were around 3% to 4%, and in Europe, it was fairly flat, because what we’re seeing in Europe is those – a large percentage of releases there are actually index based on CPI, there’s not a fixed factor, that is what the market is. And inflation has been pretty low, if not zero in Europe, so we’re not seeing a lot of year-over-year rent increases. However, a lot of that has to do with and maybe more of it has to do with cap rate compression, right? That a real headwind for earnings. So you’re only seeing part of the picture, right? You’re seeing all the cap rates come through valuations. You’re not seeing that yet in earnings. And we got to have cap rates bottom out. And once they bottom out, we’ll start to see rent growth. But I’ll tell you, it’s a great problem to have when you have $12 billion of real estate in Europe and cap rates continue to grind tighter. We’ll – I’ll patiently wait for rent growth. I’ll take that trade any day.

[Operator:]

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

[Jordan Sadler:]

Hey, Tom. It’s Jordan Sadler here with Craig. I had a follow-up, but I heard you say couple of times in the last answer about self funding development I think that was probably pretty intentional, but just as a clarification is that self fund can we use that you across sort of the broader spectrum of investment activity meaning including acquisitions as well as this point. And then separately I had a question on expense growth in the quarter if there was anything that drove the same-store spends up as first as it was?

[Thomas Olinger:]

Yes, so I’ll answer the expense growth first no there was nothing with expense growth it was really all around reimbursable expenses increased so lot of it is real estate taxes and the increase in property dollars, but again we’re almost majority triple net that passes on right to the onto our tenants pay that. The other thing I would out with our occupancies becoming this high are real slippage is getting lower as well. On your other question about self funding I do mean to say all-encompassing as Hamid, has said in the past acquisitions are hard to predict and those will get funded if they’re in a fund within in the fund so I would say, yes I think were in a position if we want to be able to fund all of our deployment this business development acquisitions anything we do by recycling capital.

[Hamid Moghadam:]

It’s interesting I think KTR was almost a $6 billion company that we bought I don’t think there are too many companies around that can actually do a $6 billion acquisition put away half of it at the time of close and have the plan that within 3 to 4 quarters our self fund that size of an acquisition I think we’ve done that, but I don’t expect you shouldn’t expect and I don’t expect us to be able to do major deals like that and still be self-funded obviously if we do major deals like that we need to capitalize the company, but in terms of our regular day-to-day acquisitions and development so yes self-funding is the way to go. And actually the other thing you should think about is that we are very over funded and in our funds in terms of our percentage interest, so we can let that glide down to the 20% and in effect have the funds be the source of our capital or 100% of the investment in those fund so there’s a lot of room on the balance sheet than in the funds take care of what we need to take care.

[Operator:]

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

[John Guinee:]

Great. Hamid, I would just recommend you, because two or three quarters ago 80% of the questions were about your need to raise equity, which you successfully deflected and proved that you don’t need to, so congratulations. But turning to the dividend question when I look at your sizable gains and contributions into the funds are you able to do that on a tax efficient basis or does that generate some tax impact and so Tom, where are you on the dividend versus your taxable minimum and how you’re thinking about the dividend going forward given your successful development pipeline?

[Hamid Moghadam:]

Yes the bulk good questions John, thank you so from a tax perspective the activity outside the U.S. is subject to tax and when we show you our margins those margins are net of any taxes we pay, so those are reflected, so you’re seeing that already we can be pretty efficient tax wise overseas with our developments, and but we do bring it back and that TI the taxable income does sit in our dividend. So I feel good this year about our ability to, but our dividend will cover our TI it’s pretty tight, so what there’s not a lot of room for margin there i.e., meaning that or I as I look at our earnings going forward and pace of development or that that’s a good trajectory for future dividend growth.

[Hamid Moghadam:]

John, I will tell you that it had been five or six years since I had a meeting with the Tom, and his team about taxable income I find myself in one of those meetings once a week so I don’t know he’s working pretty hard at it.

[Operator:]

And your next question comes from the line of Eric Frankel of Green Street Advisors. Your line is open.

[Eric Frankel:]

Thank you. I can imagine many REIT teams are too pleased with their share prices here, but I was hoping you, could comment and how that is impacting your capital allocation plans if at all?

[Hamid Moghadam:]

Well, I think, the right answer that would get us in there in the past would be that to the extent that we’re selling at a discount to NAV. We should be selling assets and buying stock back and the vice versa of that, we get that, we really do get that. But unfortunately with a business that has time frames of a year or two, we don’t run our business quarter-to-quarter and that tightly. So we need to think about where do we point the ship over a long periods of time and we’re very focused on NAV. I think your point is valid and well understood. But incremental returns on our land bank and our development at 30% margins are very attractive, and it is a constant balancing that we do. What I tell our people every time they walk in here to investment community with that proposed acquisition or proposed development, I tell them, how do those returns compare to my calling 1-800 your favorite investment banker buying back stock? That’s the answer that we compare it to. And those answers need to be compelling and that’s how we allocate capital.

[Operator:]

And there are no further questions.

[Hamid Moghadam:]

That was the last question. So thank you for your interest in the company and we look forward to talking to you in 2016, if not sooner, actually at NAREIT. Bye-bye.

[Operator:]

And this concludes today’s conference call. You may now disconnect.