Q3 2022 Prologis Inc Earnings Call
Okay.
Greetings and welcome to the Pearl largest third quarter 2022 earnings conference call. At this time, all participants are in a listen only mode.
A question and answer session will follow the formal presentation.
If anyone should require operator assistance during the conference. Please press star zero on your telephone keypad.
As a reminder, this conference is being recorded I would now like to turn the call over to Jill Sawyer Vice President of Investor Relations. Thank you you may begin.
Thanks, Darryl and good morning, everyone welcome to our third quarter 2022 earnings conference call. The supplemental document is available on our website at <unk> Com under Investor Relations 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 <unk> operates as well as management's beliefs and assumptions.
Alright, looking statements are not guarantees of performance and actual operating results may be affected by a variety of factors.
A list of those factors. Please refer to the forward looking statement notice in our 10-K, our other SEC filings.
Additionally, our third quarter results press release, and supplemental do contain financial measures such as episode and EBITDA that are non-GAAP measures and in accordance with Reg G. We have provided a reconciliation to those measures.
October started to be closed on the acquisition of Duke Realty.
As a reminder, jinx yourselves or not contained in our third quarter earnings release, however, within our supplemental.
But at a summary of the portfolio integrated as a quadrant. Please refer to our website for details on the transaction.
I'd like to welcome Tim Horne, our CFO , who will cover results real time market conditions and guidance.
We'd look at M. I C E O and our entire executive team are also with US today with that I'll hand, the call over to Tim.
Thanks, Jill good morning, everybody and thank you for joining our call.
We are clearly in a volatile macro environment, where ongoing inflation steeply rising interest rates and the warrant energy crisis in Europe are pressuring the global economy.
While we're closely monitoring each element.
Sunday rentals in our business are very strong and our read of supply and demand in our markets remains out of sync with the headlines.
This morning, we reported excellent third quarter results, which generated many new records in the quarter, you're able to spend less time on these results and more time, describing our view of the market and how we're navigating the environment.
Before doing so I'd like to thank our teams across the entire organization, who did an exceptional job keeping focus on the business, especially while working through the Duke acquisition, which closed on October 3rd.
We fully integrated the portfolio achieved our day, one synergies and look forward to the next phase, which is to build a F. F O accretion through incremental property cash flows and essentials income.
We move forward with a better portfolio, a larger and stronger balance sheet talented new employees and new customers to whom we can introduce to our essentials business.
Turning to the results of course, that's all it was $1 73 per share.
<unk> 57 cents of net promote income earned principally from our Pelf venture in Europe .
Our annual guidance for promotes was 60.
With most of the revenue to be earned in the third quarter.
The amount came in below expectations due to a nearly 5% write down of European asset values in the quarter, partially offset by an increase in NAV from debt Mark to market.
In the end the promote was a record high while the fund enjoyed a high teens annualized IRR across the three year performance period. Despite the recent markdown.
I'll note a few operating stats from the quarter all of which were records for the company and.
Ending occupancy increased 10 basis points over the quarter to 97, 8% same store growth was eight 3% on a net effective basis nine 3% on a cash basis, both were driven primarily by rent change, which was 60% on a net effective basis separately, the Duke portfolio ended the quarter with <unk>.
99% occupancy and net effective rent change of 54%.
While these metrics are outstanding there also backward looking so we've kept focus on more contemporaneous data, namely rent change on signings, which was 84% during the quarter and our lease mark to market, which now stands at nearly 62%.
Finally, we had a very active quarter on the balance sheet raising over $3 billion of debt in a variety of markets and currencies, given our broad access, including a $650 million Green bond issued in late September we.
We ended the quarter with debt to EBITDA is four three times, excluding games, providing us significant investment capacity.
Turning to our observations of current conditions, we continue to see scarcity of available space across our markets vacancy rates are at historic lows and our own occupancy sits at a record high.
Market rent growth in the third quarter remained robust in response to the scarcity and continued strong demand.
Color across the markets remains generally upbeat in terms of customer inquiries and our proprietary metrics also reveal healthy activity, even if they soften from the peak demand generated during COVID-19 to levels still above long term averages.
Transaction gestation was stable during the third quarter at 62 days propel.
Proposals by available units slowed during the third quarter to levels more in line with the pace of 2019 and indicative of less urgency to renew space far ahead of exploration.
Inside our properties our metrics points of activity that is increasing with our IV I index at 63.8, the 80th percentile and utilization up to 86, 6% the 95th percentile.
Certain customers have publicly announced a pause in capex spending, particularly those with more mature supply chains, but active dialogue with the majority of our customers confirms an overarching need to increase space as supply chain resiliency remains a top concern.
Shifting to supply.
We're seeing initial signs of a deceleration in development activity across our markets as construction and capital cost continue to increase we believe we could see a gap in deliveries emerge in late 'twenty three or early 'twenty four.
As for today are through months of supply metrics sits at a healthy 22 months up from 18 months last quarter.
We have previously explained that we expect to see this metric climb into a low 30 months range still at a level, reflecting our strong operating environment.
It's important to acknowledge where supply is being delivered as our submarket location strategies minimize our exposure to new supply for.
For example, in our coastal U S markets, where we generate over 50% of our global NOI vacancies or just one 7%.
Geographically, we have an increased level of focus on Europe , given the ongoing war and growing energy crisis.
While we are reporting record results, including occupancy at 98, 6% in a market with 2.4% vacancy we are closely monitoring conditions customers.
Customers are exercising caution in response to rising energy costs, which may create headwinds to near term demand.
That said, we also believe that new supply will now decline around 15% and 2023, which should support occupancy.
The U S remains strong where we now generate 87% of our NOI with the addition of Duke our teams continue to see solid activity, although acknowledging a reduced number of prospects for space compared to what we saw during the frenzy of told it.
Rent change on signings during the quarter was 93% demonstrating a continuation of favorable pricing dynamics.
And Latin America, both Mexico, and Brazil are performing well with very high occupancy over 98% and rent change across the region of 24%.
And in Asia construction costs in Japan are rising most acutely from the weakness in the yen as well as from competition for key materials to complete construction.
Market vacancies have increased but this constraint on new supply, particularly out to 'twenty, three and 'twenty four should provide an offset.
The combined picture was positive to third quarter market rent growth exceeding our expectations and driving a 300 basis point increase of our 22 global forecast to 26% with the U S at 28% significantly up from the 10, and 11% respectively and our initial guidance.
It's difficult to fully know the impact of this market rent growth on values given the limited transaction volume in the market, but our view is that the increase in return requirements is more than offsetting rent growth and indeed pressuring values.
Based on prior cycles, we can safely assume it will take a few quarters for full price discovery to be made as markets stabilize and transaction volumes build.
With all this in mind, we're carefully managing the business and approaching our markets with a sense of caution much as we did at the onset of the pandemic.
In leasing despite the very strong spot environment, we are carefully watching for softening demand and will assume that there will be further macro deterioration in some markets. This will have us managing more for occupancy and rent growth, but and many others. We believe pricing will remain favorable given the very low availability.
This is an environment, where our revenue management capabilities will be the most useful and allow us to manage such decisions lease by lease.
With deployment, we are reducing our starts guidance to a range of $4, 2% to $4 6 billion and we expect our fourth quarter starts will be 60% build to suit, reflecting a more cautious approach to deployment in the coming months aiming to be very selective in new projects.
And in terms of strategic capital. We previously mentioned that we expect to see an increase in redemption activity while.
While we did have inflows from numerous investors redemptions grew by $1 3 billion, which were context is just 3% of our open end third party AUM.
Our funds have sufficient equity cues to address this activity.
Combination with equity call during the quarter, we now sit at net neutral queues.
The open ended funds have ample investment capacity based on overall low leverage and we are optimistic about the long term growth of the business.
In the near term, we will be prudent as we evaluate further capital deployment, including a pause on contributions in the short term.
Turning to guidance, which includes Duke portfolio for the fourth quarter.
We are maintaining our guidance for average occupancy while increasing our net effective same store guidance to seven and a half to seven three quarters per cent and our cash same store guidance to eight and a half to eight and three quarters percent.
We expect to see our lease mark to market around 65% at the end of the year.
We now expect acquisitions to range between $1 90 to $2 1 billion.
Which increased due to our acquisition activity in Europe during the quarter and.
And contributions and dispositions to range between $2, one to $2 3 billion.
Okay.
Finally, we are increasing core <unk>, excluding promotes to 460 to $4 62 per share which includes approximately five of accretion related to the acquisition of Duke.
We are guiding <unk> with promotes to be 512 to $5 14 per share.
Which incorporates a lower promote guidance of 52.
Reflective of the higher share count, resulting from the Duke transaction.
I'd like to point out that our earnings have been unimpeded by effects over this extremely volatile year due to our capital strategy and approach to hedging.
The same is true for our equity base, which has very minimal exposure outside of the U S dollar despite our global footprint.
We will continue to protect both proactively and programmatically.
To close we're proud of how we've positioned the business and are optimistic about the organic growth ahead, we own hard assets with contractual revenues significant embedded mark to market and have meaningful secular drivers that continue to play out as an organization.
Innovation, we have long had an entrepreneurial and growth mindset today, adding new business lines and cash flow streams that are synergistic with our already unique model.
We have built the company to thrive across cycles, including uncertain environments like today, where we can seize opportunities and continue to set our business and portfolio apart.
I will now turn the call over to the operator for your questions.
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Okay.
Our first question comes from the line of Steve <unk> with Evercore ISI. Please proceed with your question.
Oh excuse me. Thanks, Good morning, I don't know, Tim or Hamid I guess, what I'm trying to sort of circle up here is that I understand why development starts would come down in light of what's going on globally.
But yet stabilization or op.
And but the contributions are down and I guess, what I'm trying to really square up is is if the funds still have capacity.
And they're still interested in deploying money.
I'm trying to just really circle up why contributions into funds would be down which is also impacting development gains. So is it a pricing issue is it a lack of leasing on the assets I guess I'm just trying to get a little more color on why that contributions numbers down and then I guess I can understand why dispositions would be down in this on <unk>.
Certain capital markets environment, but I'm, just trying to get a little bit better handle on the contribution side.
Yes, Steve Good question its actually none of those reasons. The reason the contributions are down is that I made a decision that we are gonna stop contributions until we have much better clarity on valuations because one of the lessons.
That we in the former Pearl I just learned.
In the last cycle is that it's really really important not to force any issues. When there is the least bit of hesitancy around values.
You know as much as we have ideas about what values are and where they're going we don't have absolute certainty about that so it was completely voluntary decision our leasing of our development business is actually ahead of what what are the way we underwrote the properties and there is no external constraint on us including capacity of <unk>.
Which the funds continue to have some theyre getting some redemptions, but they have plenty of leverage capacity and and we continued to raise money even in this environment not as much as we did before but we continue to do that.
I would just add Steve in relation to your comment on gains in next year I would just point out that the value creation is occurring regardless of that monetization event. If we hold the development assets on our balance sheet. It's still there at a very attractive yield and we believe many of those assets will still find their way to the fund. It's just a time a pause.
Now.
Okay.
Thank you. Our next question comes from the line of Craig Mailman with Citi. Please proceed with your question.
Oh God.
I just wanted to go back into your commentary there was I think in overarching.
Message that fundamentals are still very strong and way it looks to me you could still have accelerated quote well into next year, but at the same time <unk> mentioned that some markets you guys.
On the revenue manager in here I, just kind of like.
Little bit of color.
Maybe but settled above multiple floor.
How we should think about what's really at risk from a fundamental perspective, and then also just as it relates to do.
Clearly get rates have moved against you a little bit so relative to your initial accretion that's probably a little bit of a headwind there.
I'm just curious to know as you guys kind of starts.
Kind of coming down a bit this year.
Where's your updated accretion number.
Core <unk> for the first 12 months.
Alright that was a that was a couple of questions in one big question. So let me take parts of it then I'm sure attempt Tim and Dan will have follow up on this in terms of fundamentals. What we're saying is that if a normal range of market outcomes is kind of zero to 10.
We were operating in an environment that was maybe hit 12 for the last 18 months and that's coming down to sort of a nine nine and half today and that's why we shared with you the percentiles of utilization and occupancy and business activity that are part of our proprietary data that we survey customer.
So by any measure other than the last 18 months I would say, we're in very strong market conditions and during those periods of sort of 99 and a half and there are always a couple of markets that are weaker than others.
They are the key markets are exceptionally.
Strong I mean L. A basically L. A in the inland Empire, there's no vacancy in New Jersey, there's no vacancy and so on and so forth. So but there are markets where vacancy rates are in the five 6% range that by historical standards.
A very low level of vacancy. So so I would say I would characterize the fundamentals as being very very strong theyre just not off the charts given what's happened in the last 18 months.
With respect to the Duke portfolio and margins and alike.
Dan can elaborate on this but we've never underwritten the exit cap rates.
Two what the peak has been in the last 12 to 18 months, we've always taken added the premium for the forward risk and just the fact that basically these were unprecedented times and a lot of the margins that you saw in prior quarters from us reflect that that level of conservatism and you know.
Rents are still going up I mean, we started 2022 thinking rents are going to be up 11% there are up 28%.
Yeah cap rates have gone up but the rents that are being capped are significantly higher so bottom line margins. If you really stress test everything okay and.
And you say rental growth stops cap rates go up et cetera, et cetera construction costs go up.
Our development pipeline goes from mid Fourteens margins too high Twenty's margin type of thing so what still double what we underwrite to a week.
Usually underwrite to mid teens.
Extremely strong operating environment, and we are just being cautious.
On the capital market environment, as we have to be it would be imprudent, if we werent.
Okay.
And Craig I'll, just pick up your question on the debt and Duke you're right since we announced the transaction in June depending where you are on the on the curb or 100 or 200 basis points higher in interest rates. So that does hit the debt mark to market piece of things I think if we were redoing the entire accretion on the year, we'd be still in the range, but at the low.
And of that original 20 to 25 cents.
Today.
Yeah, but I would also say on the fundamentals of the real estate we're.
We're ahead of where we underwrote.
So I think that far outweighs and mark to market on the debt I mean, both Duke and US were very low levels of leverage so the mark to market. It just not not a big deal in our in our calculus.
Thank you. Our next question comes from the line of Gerrick Johnson with Deutsche Bank. Please proceed with your question.
Hi, everybody good morning I'm.
Just touching on European occupancy you certainly had a positive bump to 98.6 and you know clearly pushed NOI, but can you expand on which geographies led really the sustainability of EU demand. What you guys are seeing on the ground in any additional leasing comments. Thank you.
Some of the weaker markets in Europe have strengthened like Spain would come to mind or France would come to mind that trip perennial strong markets in Europe , where the U K and Germany is strictly in northern Europe and they remain strong.
Wouldnt be surprised if Germany weekend, a bit in the U K, we can debate.
In terms of weak markets in Europe .
I would say if you really forced me to name one I would say, it's hungry, which is a very very small part of our overall business Poland is actually too much to our surprise pretty strong it must be because of the in migration of a lot of Ukrainians into Poland and the additional consumption that they drive.
But our markets in Europe are tighter than they are in the U S. In aggregate and that's why why vacancy rates are lower but there's no question that Europe will have lower growth or or more and.
If we go into a recession and bigger of a recession in the U S. But by no means is it is it leak it quite quite to the contrary pretty strong.
Yeah.
Thank you. Our next question comes from the line of Nick <unk> with Scotiabank. Please proceed with your question.
Oh, Thanks, I just wanted to touch on your <unk>.
Sort of thinking about it as we are heading into a weaker economic environment. Most people same fears of global recession coming if you could give us.
Some context of how to think about occupancy potential occupancy impact to the portfolio I mean, I think most most of the third party brokerage firms or.
Starting something like 100 basis points of U S. A vacancy increase next year because of slowing absorption some supply picking up I.
I guess I'm curious what you thought about that and then also from a credit loss standpoint.
How we should think about the portfolio and in sort of a historical context kind of framing out you know where you have sort of a credit watch list today and potential occupancy impact on top of just an overall market occupancy impact from a credit loss standpoint in the portfolio. If we are heading into a recession.
Sure on credit loss.
The average over 10 15 years has been about 15 basis points, and we underwrite a lot higher than that but that's where we've averaged.
During the most acute times of Covid in the first.
Quarter.
Quarter of two when nobody you know when there was all of that loss of jobs and everybody was scared that went up to 50.
55 basis points, but.
But we collected on all of that credit reserve that we had set up because eventually everybody paid so I don't know, where we ended up with but we essentially ended up at zero or maybe in line with the 15 basis points of historical numbers I don't think we're going to see it anywhere near that I think there is a fair amount of demand today.
That is not being satisfied in the market because of lack of supply.
I can see you're right just to pick a round number of 4% even if they were to go up 100 basis points, which I don't believe they will.
Be at 5%, which we would all do cartwheels for.
At any time in the 43 years that we've been in this business. So.
I I'm, you know what I mean.
Just do the math on the numbers assuming that the development pipeline has zero more leasing I don't mean for Prologis I mean for the marketplace.
And the end demand falls off significantly that's how you get to the 100 basis points and I. Just don't think it's going to be that acute given what we're seeing in terms of customer interest in our spaces on a real time basis.
Thank you. Our next question comes from the line of Michael Goldsmith with UBS. Please proceed with your question.
Good morning, good afternoon. Thanks, a lot for taking my question Mike.
My question is on the promotes I think heading into the year, we talked about 'twenty 'twenty 2023, promote being similar or higher than where it was going to be in 2022, just given where valuations have changed and there's different dynamics at play.
Should we be thinking about the dynamics at play for next year on the permanent side.
Promote levels are very sensitive to exit cap rates that you assume so that's a pretty tough question to answer, but if we stress test our numbers from.
The last time, we spoke.
To promote our four U S. A less next year is going to be on par with what it is this year for pals.
That number can move in either direction by significant amount, depending on what to what happens to exit cap rates.
And by the way, but they are both of those years 'twenty, two and 'twenty three will be record for almost by a factor of <unk>.
Two or three.
Okay.
Okay.
Thank you. Our next question comes from the line of keeping Kim with Truest. Please proceed with your question.
Thanks, Good morning, I just wanted to go back to the question about contribution on your fund business.
Can you remind us what the pricing mechanism for your bonds for you to contribute assets.
If I remember correctly that that will go up.
Broker appraised, but obviously you don't want to force.
Into your fund investors. So I'm just curious what is causing.
The pause.
Pause or temporary pause and contributions as a just an agreement or.
Our agreed upon price hikes, you can't come to you or is it something different and the second question.
Hamid if I think about the business the bigger picture.
If we didn't have if market volatility I would've expected your company to contribute an increasing level of asset to your fund business because you have to kind of keep up with the development pipeline.
But given that that's probably not going to happen how should we think about.
The company is taking on more assets on the balance sheet better for earnings, but also a higher leverage I'm, just trying to better understand that dynamic going forward.
Yeah.
On the funding contribution question.
We would be happy to contribute to us continuing to contribute the deals if it were not for our.
Care in managing the long term value of the franchise and in.
Our private capital business.
We haven't even tried and we will not even tried to contribute these assets that are being completed because we just don't think it's the right thing to do.
Got nothing to do with the appraised values or or capacity or any of that stuff as I explained before we just think until there is real clarity that that will take some time and they have to be some comps and some transactions.
And when there is clarity will start contributions again as you know unlike the last cycle. The contributions today are not must put must take there are totally voluntary by us to offer those properties to the investors or not to offer those properties to the investors.
We just not going to force that issue and it sounded like they've turned us down or or we think the values are too low the values are great.
We would still have significant 40% margins. If we contributed its purely voluntary and I think it's the right decision for the company in the long term.
In terms of its impact on leverage obviously, if we decided to hold more assets. We our leverage is going to go up but our lever. The reason we built this balance sheet is exactly for situations. Like this is to be able to a be able to hold more of our assets.
That we are developing they're perfectly good assets that bad and so at some point in the future will contribute and and we're happy to hold those and if the level and the other purpose for the balance sheet is to take advantage of investment opportunities as they emerge it's still too early because I think the valuations will settle.
All out somewhere lower than where the appraisers, probably think today, but I don't know that for sure.
By the way, we've been doing listened to a word I'm, saying with respect to valuations because for five years, we've been saying the cap rates are going to go back up and they finally did I guess, but but we've been really wrong and frankly too high in cap rates for all this time.
Oh, one other thing that's important I should've mentioned this.
We had never written up our portfolio. So the peak cap rates or underwritten any of our development to the peak cap rates that we're seeing in the marketplace. We were always assuming exit cap rates that had a premium built into them I think I mentioned that before but that premium was anywhere between 50.
<unk> 200, 7500 basis points, so a lot of what youre seeing in idle yet likely to see in values is already reflected.
And the way we looked at our margins and we further stress test those numbers and I think I shared their.
The results of that with you earlier.
Yeah.
Thank you. Our next question comes from the line of Tom Catherwood with <unk>. Please proceed with your question.
Thank you and good morning, everyone. Hamid you mentioned tenants with more mature supply chain slowed their capex spending.
Obviously, we've seen that the headlines as well are you seeing though any give backs or non renewals from those tenants you know, whether it's fedex or Amazon or others and specifically what are the tenants or industries that are back filling this gap in demand.
Okay, I'm going to let Mike give you a broader view of demand other than the customers you asked about but let me hit those too.
We have zero give backs on Amazon.
Zero, we thought we're going to have two out of like a 160, we have zero and they continue to take new space from us. So I don't know what all of this excitement is all about but we haven't seen that in the marketplace. They were on a tear in 2020 in 'twenty, one and they probably over committed to <unk>.
Space and they just a reel that back a bit.
But they talked about 30 million feet coming online. We don't think it's even going to be 10 million feet and none of it is in the spaces that we have so that's Amazon Fedex is consolidating some of its ground operations with airport operations, we're going to be a beneficiary of that and we're not going to lose any fedex business as it was.
Out of that and we're in in regular conversation with these people. So are those two customers specifically no issue and we have vetted. This about as best as anybody can with respect to the broader customer Victor Mike Yeah, I would just add.
And a finer point to that we're going to see other headlines coming down the Pike I'd encourage you to really look through the headlines and understand the numerator versus the denominator in play here and we're talking just a pile on to <unk> comments.
Fedex mentioned order magnitude 100 projects, they're pausing in the future that set against 15000 spaces. They already have Amazon to put a finer point on that.
You know even if they are at.
They have 550 million square foot portfolio. So we're talking 1% churn kind of numbers here, which is a very normal churn we see for our larger customers that have thousands of spaces. I think it's important when you see the next headline to look beyond.
One of those headlines in terms of where the other activity is and Chris can pile on as well here too but E. Commerce clearly is the big driver and we're seeing e-commerce levels in our own portfolio.
Just ahead of where we were pre COVID-19 the big difference is.
Amazon is not a part of that this quarter there temporarily pausing and we're seeing 122 other customers not named Amazon driving ecommerce leasing at levels. We saw pre pandemic I think that's the big drivers of the big takeaway for the segments that are supporting the snapback.
Yeah.
Yeah.
Thank you. Our next question comes from the line of Vince to go with Green Street. Please proceed with your question.
Hi, Good morning, you.
You increased your market rent growth forecast in the U S. At 28% this year, how much of that growth has already been achieved at the end of the third quarter I'd like to hear just how much you think market rents can continue to grow in the current environment.
Yeah.
Hey, Vince Yeah that the increase is X.
Exclusively based on the outperformance in the third quarter, we thought and the present landscape it would not be appropriate to make an increase as we look into next year I think it's appropriate to expect you know me.
Mid to high single digits.
<unk> had mentioned we opened this year with a similar level of caution and have seen subsequent increases we monitor this on a real time basis, let alone reporting out on a quarterly basis and some of the things that go into that is the ongoing significant momentum right. So rents were up 6% in the quarter.
Against ultra low vacancies healthy demand healthy leading indicators, but set against set against the macro uncertainty that we've described so 75% to 80% of the 26% 28% has already occurred.
And we expect the balance of core and the balance of the year and by the way. We're only a couple of weeks into the quarter, but again every time, we make a deal we know what the effective rent is compared to the way, we underwrote it and and we call. It spear I won't get into the details here.
Here, but but those indications are up.
In terms of comparison to underwriting.
Or the way, we had pro forma those spaces and also in terms of duration of leases, they're slightly longer than we thought.
Okay.
Thank you. Our next question comes from the line of Todd Thomas with Keybanc Capital markets. Please proceed with your question.
Hi, Thanks.
Wanted to follow up on on Duke Tim Thanks for the update around the 20% to 25 of year one.
Core <unk> accretion, but I'm curious you know Hamid your comments suggest that Duke's running ahead of your initial underwriting. So im curious if theres been any change to your underwriting such that the year, one <unk> impacts changed at all relative to your initial expectations and then.
Secondly, regarding the core <unk> guidance.
Excluding net promote income can you just help us bridge that one 1% increase at the midpoint from the prior guidance now that <unk> closed and just discuss the drivers of that increase a little bit it sounded like the quarter came in ahead of budget or plan, which I suspect contributor, but the increase of five <unk> at the midpoint I think you attributed solely to do.
Was there anything else that was an offset in the quarter to the stronger growth.
Yeah, just I remember duke's leases were longer than ours. So the average turnover based on the average duration of the Duke leases is like a 10% to 12% a year I don't remember what it is exactly in the next 12 months.
Your question was on and we think we're a couple of points ahead.
A couple of points I had affecting 10, 12% of the portfolio for an average of six months is what we're talking about in terms of its impact.
On the next Oh in the next year. So it will be a small impact I think the bigger impact will be what we can do.
Once we get our hands on the rest of the portfolio rolling over through revenue management.
And we think overall, maybe that could be two years or 3% above underwriting.
I also think there'll be a couple of hundred basis points pickup in terms of folds.
Holding essential sales on top of that but it will take a little while for us to sort.
Sort of build those relationships with those customers in those locations and all of that.
On the second part of your question, Tim Tim will address that yeah, you're right that the the.
The quarter was strong we were probably a penny ahead, there and that would be reflected really in the same store guidance. Overall that we took up we would see an uptick on the year from from that uplift as well as we would get a little bit out of this slowdown in contributions in this in the short term offsetting each of those putting putting the group to about zero would be.
A little bit higher interest expense you know you've got short term rates are really ticked up and then the write down of asset values in the funds does hit asset management fees. So that would be another takes so that's all coming up to about zero, leaving.
Really the entirety of the accretion to the Duke transaction.
Yeah.
Thank you. Our next question comes from the line of Blaine Heck with Wells Fargo. Please proceed with your question.
Great. Thanks, Good morning out there I mean can you expand on your thoughts on the broader economy I think your remarks in the earnings release indicated that you are preparing for an economic slowdown does that include a U S. <unk> global recession, and how should we think about your development starts in 2023, given that you've now added.
Capacity through the Duke transaction, but seem to be more cautious here today given macro concerns.
Yeah. My view of the economy is that the fed was behind the eight ball and they now really running hard to catch up and theyre going to overshoot and their reaction and everybody expects. These things they have an immediate effect look I'm not as smart as the guys running the fed, but but these things typically habits.
Two year lag. So I think we're gonna with this economy and there is no reason this economy should be in a recession other than just wanting to wring out some inflation and this is a personal editorial this is not a company position, but I believe more based on what I'm seeing.
Are more of the inflation is actually.
Affected by not that systemic wage price push that we saw in other areas times of a high inflation by the way I was there.
When I started my career as a 10 year bond was 14, 14% and prime rate was 22%, but that was a that was a.
Psychology that was built into the marketplace I think and it took volcker in October or <unk> 79 to wring that out, but you know the market had gone six or seven years with that becoming the norm. This is very different than where we were just talking about 2% inflation a year ago and it just spiked up so a lot of that I think its dino.
Dissipate as things normalize and trade flows and the like normalized but that's a personal point of view. So I am concerned about an inflation I think the fed's all kind of overdo it.
Whether we have a recession or not I don't know why people are so focused on this recession question to me at 0.25% growth rate in the G. D. P. When the potential is two two and a half for the U S and one and a half for Europe is a bad thing now whether technically a bunch of smoke will come.
Out of the pipe that says you know we officially have a recession, that's less important but we are definitely under kind of underperformed the capacity of this industry. The consumer is in great shape. The consumer balance sheets are in great shape. So I see a lot of reasons.
For optimism I mean look at all of these calls that we were all having a quarter ago I think the psychology has changed dramatically because of all this aggressive fed action. So I've done a good job of not answering the question. If you had asked me last quarter, what's the probability of a recession in the next year I would have thought.
June 19th 10 today I would go.
I would go 60, 40, or maybe 50 50, I think we're much closer to in the U S. I think in Europe , We will go into a very slight a shallow recession.
With respect to its impact on development starts I think the market is under supplied with space.
But we don't have to make that decision today. We don't every restart decision is made to deal by deal and we will have the benefit of up to the minute information and actually some information about the future because we're talking to prospects. So if we think the prospects are there to lease it up we'll build the building and if not.
Well I don't really care about guidance, we try to give you the best guidance, we can but we don't run our business. According to guidance are we could be we could be higher I think we're going to surprise people on the upside, but but let's wait and see we don't have to make that decision today.
Yeah.
Okay.
Thank you. Our next question comes from the line of Ronald Camden with Morgan Stanley . Please proceed with your question.
Hey, just going back to the lease signing of 84% during the quarter.
Where does suggest that the commenced Ah commence leases should be accelerating as well, but how do I marry that with the full year same store NOI guidance, where you're guiding for $8 65 for the year, but year to date is at $8 seven so, suggesting a little bit of deceleration.
Trying to understand what could be driving that is it occupancy comp.
This is the lease signing that's accelerating.
Yeah. Ryan look this is a good opportunity actually to distinguish the two metrics. So the commencements were 62% and that's why we're actually calling out.
The 84% on signings because of the lag that sits between the two you know the the lease signings on what started this quarter generating 62% were probably done in the first quarter. So all of that means that the 84 were signing today, we're really not going to see those commence until 'twenty three outside of the same.
Store period, and they're in our guidance.
So that's why we're actually focusing on signings, you'll probably hear a bit more of that going forward.
Okay.
Okay.
Thank you. Our next question comes from the line of coming all bottle with Bank of America. Please proceed with your question.
Hi, Lisa.
The spread between market rent growth and lease escalations widened over the past two years can you talk to what percent of your leases have fixed structure. What are the escalators are achieving on new leases and how sustainable do you have the duration of the race.
Virtually all our.
Leases have escalators.
I would guess the average is three and a half ish, maybe approaching four yes and.
Yes, four I'm getting a lot of course thumbs up here.
And I would just clarify that the installed base is probably the three and a half you mentioned and then more recently.
<unk> recently for Yeah, and I think that was it did you have a third part to your question.
Yep.
Yeah.
How sustainable these increases ourself deterioration of Ali.
Well they are contractually obligated to increase so.
It's not the end their contractual they're not CPI driven or anything like that.
So.
Yes, unless the tenant goes broke there's no risk to that.
Yeah.
Thank you. Our next question comes from the line of John Kim with BMO Capital markets. Please proceed with your question.
Thank you.
I realize that the market is very fluid, but I did want to ask about the four 1% cap rate.
Stabilized.
Oh I'm sorry.
I guess industrial would be the one asset class that you could argue the most of our negative leverage given the strong mark to market that you have by new developments or find basically at market. So it doesn't have the same mark to market potential so.
So can you make the argument or couldn't you make the argument that new development should be at a higher cap rate, which I know it's counterintuitive.
It has been recently budgets reflective.
That market today.
Yeah by the way I don't think there is any negative leverage even today.
Let's just go to basic principles. There is an interest rates are going up is because we have inflation.
Real estate is in a tighter market equal weighting equilibrium situation. So there's pressure on real rents going up if we continue in an inflationary environment where rates are up we're gonna get more rental growth not rental growth because they can see rates are very low.
So really in terms of IRR, we have positive inflation plus excuse me positive leverage and that's the way. It has been for 30 years of my 42 year career.
Positive leverage on IRR, not necessarily positive undergoing in cap rate or cash yield compared to interest rates. That's just the way the business works it's.
Its total return dependent and total return in the high interest rate high inflation environment is going to have a bigger growth component to it unless the market is 10, 15% vacant.
In which case inflation doesn't matter you don't have pricing power, but we expect that pricing power for the foreseeable future even in a in a really really conservative absorption scenario and I went through that.
Before I can't imagine a scenario anytime soon where vacancy rates would with breach 5%.
So I think we will have pricing power and I think we have positive leverage on an IRR basis and by the way short term rates have moved up a lot more than the long term rates.
And really real estate is an infinite life assets. So you've got to compare its returns to 10 year or more longer.
Tim I just wanted to clarify John maybe you see this but I want to be sure. You note that we have in the supplemental both the exit cap an estimate on it and the development yield I think you are quoting the exit cap the development yields are 665% in the in the portfolio. So I wanted to be sure you understand the distinction.
Hence the huge margins.
Thank you. Our next question comes from the line of Jon Petersen with Jefferies. Please proceed with your question.
Great. Thank you I was looking at the sort of promote opportunity next year for the targeted U S Logistics fund.
Realize it's volatile and there's a ton of assumptions that go into this but maybe you could help us and remind us what the hurdle rates are that you have to hit each year to be eligible for promote just kind of how that structure works. Once you hit the hurdle like what percent of the NOI you get so we can all be dangerous and make our own assumptions and then another question I have is on the land portfolio I think you have it on the book.
It books at a $2 7 billion.
Any estimate on how we should think about the market value of that land portfolio today.
Yeah, I think market value of land was double our book value and my guess is before this resolves over and not a single piece of land has not really traded them in any in any scale. So that I can give you an actual estimate but I would.
Guests land values before it's all over will decline by 30%, which would put them still significantly above our book value.
So that's where we are I think I think that promote hurdles are seven and it's a 20% part.
Yeah.
Yeah, and we have two hardware promos actually seven and 10 and 15 in 'twenty is the upside participation in those and those are leveraged.
Hurdle rates.
So <unk> 720 over time.
Okay.
No.
Okay.
Thank you. Our next question comes from the line of Anthony Powell with Barclays. Please proceed with your question.
Hi, Good morning, I had a question on acquisitions.
About the cross Bay deal what brought you to that transaction I mean, you talked before about maybe more portfolio deals happen in Europe or are there more deals out there and what's your I guess your willingness to do more deals on the balance sheet, given kind of the overall macro environment.
Okay.
Yeah. This is Dan I'll take that question. So the cross Bay deal closed last quarter, we I think first introduce that deal.
But in February .
We are we were able to.
When we first talked about this deal the bid ask was pretty far apart.
You're able to.
When that deal at a very favorable price, we actually got a couple of price reductions and we really love the real estate, it's very complementary to pulse.
And.
The team is very very excited about bringing that on.
As it relates to other portfolios the way, we think about deploying capital right now I think about really discipline I think about patients and I think what opportunity we've always run a very disciplined deployment machine.
And our teams boots on the ground are calibrated for that and are excited about it we're being patient right now because we do expect to see opportunities that come from it is a matter of fact, we're making money today based on decisions that we made in the depths of the GSC. So.
We're really excited about what opportunities could come.
Okay.
Yeah.
Thank you. Our next question comes from the line of Michael Carroll with RBC Capital markets. Please proceed with your question.
Yeah. Thanks, I wanted to touch on an earlier question to see if we can get a little bit more information regarding the larger users with a more mature supply pipelines I know you touched on a few examples but in general how big is this bucket of these larger users slowing down I mean is it mostly Amazon and I believe you mentioned a Fedex is there like a few others.
Outside of that or is that about it.
Okay.
Everybody is running to catch up on their e-commerce supply chain, because they're starting behind and they need to catch up.
So the demand for E comm space is broadening but remember E. Com is just maybe 20% of the overall demand.
At the same time that thats going on people are building resilience in their supply chain. So our.
Inventory levels have adjusted upwards like we predicted we think half of that adjustment.
Has already occurred and there's another half of it to go so I think you'll see all customers are virtually all customers building more resilience into their supply chain by by taking up more space. So that they don't get caught with the wrong inventory in the wrong place at the wrong time, but the demand is definitely routing.
Mike do you went out and I think I could.
I'll give you a sense on.
All customers are being certainly more introspective and cautious these days that's natural in times of uncertainty, but if you look at our build to suit was for example, it's a it's a narrower list Amazon's currently pausing, but the customers that are on the list are still following through with long term supply chain reconfiguration that had been in place for a long time and they are following through with.
Those were the same.
Efforts that we've seen before so I would say if you look at build to suits its a smaller more active list.
Of customers and in our competitive environment looks even better if there's fewer private competitors out there that are direct competition given the current market conditions, So I view that business as smaller.
But a deeper prospect list with a higher win rate possibility. So that's one perspective, yes. The point, Mike just made about the competition on the private side.
<unk> is a really really important one I mean these guys depend on leverage leverage is not available. It's not just the question of the cost of it through a lot of these people. So we've already seen certainly layoffs in Europe .
With respect to some of these very aggressive private guys and I think we will see some of that in the U S. Too. So again. Another reason why we have a good balance sheet is to use it when when the opportunities are there.
Yeah.
Thank you. Our next question comes from the line of Mike Mueller with Jpmorgan. Please proceed with your question.
Yeah, Hi is your 65% year in these mark to market expectation with or without Buchanan.
That's with.
Okay.
Yeah.
Okay.
Yeah.
Thank you. Our next question comes from the line of Dave Rodgers with Baird. Please proceed with your question.
Yes, let me thanks for the details on tenant credit that you provided earlier I wanted to go back and maybe this is a draconian question, but when you go back to the global financial crisis, I think PLD lost 600 basis points of occupancy top to bottom some of that might have been credit loss, but even though it is not credit loss and some tenants may leave just due to the same factors that we're talking about I guess, how does today differ and I.
I'm just a little worried about the convexity of non investment grade now above 10% those types of things.
How does your portfolio differ how do you think the market differs and then maybe a follow up to Chris.
Last quarter, you had suggested a 75 basis point increase in vacancy for 'twenty three for the market as a whole has that number changed thank you.
Okay.
I'm not sure I understood the second part, but the first part first of all I do.
No about Prologis, but I think there was 52 million square feet of spec space that they had built at that time.
And.
And the company at that time was I don't know 400 million square feet or something it was a huge part of the installed base and most of them are spec. So you went into global financial crisis with a collapse in demand and you were starting off of seven with a seven or 8% vacancy rate even before.
Going into the global financial crisis. So it was different at least in three respects one level of spec development to the starting level of vacancy and three the impact of that on a much smaller company and today.
So very very different situations, let's and and then up but the numbers for AMB, where that we went from mid 90 fives occupancy to 91 occupancy and by the way the exact same thing happened.
In the in the Dot com collapse.
<unk> was up you know people had over committed to space.
The difference is that the shadow space in this market is very low that's why we look track utilization.
90th percentile utilization in the buildings in terms of history. So occupancies are high utilization is high there's a.
A lot of ongoing demand and we're starting off at the 98% occupancy.
Even if the global financial crisis, we're going to repeat itself will be at 94% of occupancy that that that's just fine. There's no problem with that we can get rent growth.
Those kinds of numbers, so I don't even think of those draconian scenarios of course, you know.
Somebody launches a nuclear war somewhere all bets are off, but but I'm not capable of making.
Dave as it relates to the forecast we shared you remember correctly because the units wrong. So we had said we could see a supply demand gap of 50 to 100 million square feet next year, which would only be $30 million 30 basis points of occupancy increase.
Our latest view probably has it at the higher end of that range say 100 million square foot gap, which would lead to a.
High threes, or a 4% market vacancy, which again is below the low that prevailed during the decade before and I'd also call out.
In Tim's script that based on the capital market landscape, we could have a gap in development starts that would ultimately translate to a GAAP in deliveries late next year or in early 'twenty four.
Yeah.
Thank you. Our next question comes from the line of Bill Crow with Raymond James. Please proceed with your question.
Good morning, Thank you.
Two questions first of all any change in the lease up time on new deliveries and the second question is you've talked a lot about cap rates and.
Cap rate.
Creases over the last six or seven months I'm. Just wondering if you were to underwrite an acquisition today, how would that change too.
Where you were early this year, let's say how much how much do you think cap rates are capped out on a like for like deal.
I can start on the lease up times and I think Hamid made reference to this just that compared to underwriting we've consistently be underwriting and that would remain the case today, maybe maybe theres a month lower there, but we're continuing to beat underwriting and new development leasing and then yes that I would say on the cap rate side, you see it in our development port.
In the supplemental we moved our exit cap rates from four one to $4 seven so thats the sort of the change that we're looking at across the board.
Going forward.
If you and I would say for the last couple of years, we're looking at about a 6% unleveraged IRR in acquisitions using about an average of a 3% growth rate.
Rents and that gap is 300 basis points by the way that's the most important number that you look at.
That I look at anyway and replacement cost.
So if you believe inflation is going to be higher at 4%.
Rents rents will grow at least that claims inflation, given what's happening to replacement costs and given the tightness of the market. So you could expect with a 4% growth rate that.
That the IRS would be seven seven and a half going forward. So the point I'm trying to make is that you just can't look at a discount rate of those cash flows without considering the growth rate of those cash flows and those two they'll move perfectly in tandem, but generally move in line with one another.
In a market that has a vacancy rate below equilibrium.
Okay.
Thank you our final question will come from the line of Jamie Stockton with Wells Fargo. Please proceed with your question.
Great. Thank you and thanks for taking my question.
You know we were just thinking about how should we think about FX and how that goes into your calculus, when you're thinking about investment activity given our strong U S. Dollar is and your unique global platform.
And then secondly, if you could just give us some thoughts on when you think the mark to market stops expanding I think it's been surprising to us how it just keeps growing quarter after quarter I'd love to get some thoughts on.
When that might moderate.
Yeah.
Yeah, So FX, sorry, I'll give you the big picture through her in and Tim can give you the details.
We do three levels of FX management number one we wanted to have a global platform to serve global customers, but we do not want to have our capital equally in every place because we're a U S dollar dividend pay therefore, we use a higher percentage of private capital.
In our foreign jurisdictions than we do in U S jurisdictions. So thats. The first step that we take secondly, we have a disproportionately higher amount of debt.
In foreign currencies batch the games are equity or our share of the equity in those assets. So that we are neutralized in terms of asset and liability movements with respect to the movement of interest rates in other words $100 of of equity $100 of debt against it by the way the U S.
Much less leverage so our overall leverage is very good. So that's a second level that we manage the asset value, which is really the big dangerous thing in real estate Sandoz were perfectly hedged perfectly hedged and.
Not overhead should not on their hedge perfectly hedged then there is the issue of how do you manage earnings FX on earnings which is more of a flow management and that is by by buying hedges that are go out and protect earnings for two ish kind of years.
Yeah, and I would say even longer we ladder into that strategy, where in the next few years are quite fully hedged, but we have hedges out to 'twenty six 'twenty seven and we dollar cost average into it I also think Jamie it sounded like underneath your question is how do we feel about spending dollars to Europe or to Japan, and frankly, that's not really how it works you know in these others.
The restrictions.
Typically recycling capital.
When we're running the contribution muscle even at a time like this when the contributions and at least in Europe are at a pause.
We're funding that with that in country. So we don't really have the kind of issue I think you're trying to highlight there.
Second question was on the lease Mark to market I think and how does it fall down overtime and I know you appreciate that's going to be purely a function of what is market rent growth from here you know if there were no market rent growth that will come down more precipitously.
If there's a reasonable level say.
High single digits, that's probably going to be paired with our same store growth and that would say the lease mark to market is going to be.
Pretty constant for a while so you have to make a bet on market rent growth to really answer that question and we're not doing that today over the over the long term but.
It's got a very long tail to it I think is our view.
Finally, I would also say that the FX rates being so favorable to <unk>.
The dollar Bill there will become at time.
Where there would be compelling opportunities to deploy capital in Europe .
Because you could catch that combination of good values in local currency and a great exchange rate. So we're not.
We don't expect to do that tomorrow or anything, but but that's another consideration that we always keep in mind, which is the opportunistic side of all these changes that we're witnessing before I. Let you go however, I'd like to take a minute to highlight our granberg keeps conference, which happens next Tuesday at Hudson.
In yards in New York.
It will also be streaming online.
This is an annual thought leadership event, which will feature some of the most innovative voices and logistics today, including Dave Clark, formerly CEO of worldwide consumer at Amazon and now the new CEO of select sport, which is actually one of our portfolio companies plus.
Host of others that you won't want to Miss will dig into all of the questions that you've been asking about in terms of macro trends and and and I think it will be a bit very different event than you know yet another REIT recombinant or something of that kind. So if you're really interested that bad logistics center and win it.
Moving in the next.
A couple of decades. These are these are the people that we brought together so look forward to seeing many of you. There we've had a tremendous response.
And I think you'll get a lot out of it so please call take care.
Thank you. This does conclude today's teleconference. We appreciate your participation you may disconnect. Your lines at this time and enjoy the rest of your day.