Prologis Inc (PLD) — Q1 2017 Earnings Call Transcript

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

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

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

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

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

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

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

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

I think it was worst.

I’ve heard it, yes. So, it’s fine. Alright, Sharma is on. We’ve been monitoring some demand for logistics assets in Europe and globally, and have recently observed more conversations about last mile delivery, especially as it operates in the Continent. I believe Amazon was in the news over the weekend mentioning the need for around 1300 last mile warehouses in the Continent. I just wanted to understand how your portfolio, particularly the European one, is configured in terms of last mile versus bulk delivery. Additionally, how does the CBRE co-venture fit into this, especially regarding the U.K. market?

Okay. That was two questions, but since they misspelled your name, we'll let it slide. Let me start with the last question first. The reason for the U.K. joint venture is that our existing funds have limited capacity to absorb completed products, while our U.K. development team can create high-quality assets at strong margins. Thus, we needed a place for our excess development volume in the U.K., which is why we formed this center. It's quite straightforward. Regarding the last mile industrial real estate, I can share both a cynical and realistic perspective since there are two viewpoints. The cynical perspective suggests everyone is trying to improve old, obsolete, and poorly located last mile assets to achieve better cap rates on sales. I can assure you that's not our approach. We are intentionally targeting last mile opportunities by investing in infill sites in major metro areas globally, particularly in the U.S. and Europe, to redevelop and enhance assets by creating multistory buildings in constrained locations. In fact, we recently broke ground on our first property of this type in the U.S. last week in Seattle, and you can expect further announcements regarding similar properties. Remember that we essentially merged two company strategies; prior to the merger, AMB focused more on infill in large markets, while Prologis was more about bulk. We have now aligned those portfolios globally, but there remains a significant focus on near infill last mile opportunities. The terminology isn't as important, but infill real estate in major metro areas largely consists of the former AMB assets. AMB's presence in Europe was smaller than Prologis, which suggests that we find more opportunities in the U.S. compared to Europe. However, we are equally committed to pursuing those opportunities in Europe, and you will see us actively addressing this area with ongoing initiatives.

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

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

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

I don't have any unique insights on retailer bankruptcy, but I can share that we carefully monitor credit loss in our portfolio and evaluate every tenant's credit across all industry sectors. In our typical projections, we anticipate about a 0.5% credit loss, while we're currently running at 20 basis points. This is significantly below the trend. For those familiar with past crises, such as the global financial crisis, our credit loss reached the low 1% range. Regarding troubled retailers, our exposure to them is less than 0.5% or 1% of our portfolio, and in many cases, we would prefer to forgo the space entirely rather than keep those tenants. So, it's not one of my main concerns.

Thanks. Can you provide more details on the impact of consolidating NAIF and the benefit to full-year FFO? From a yield perspective, it seems like you might have mentioned some pro forma NOI adjustments. It’s unclear if that was for a full quarter or not, but it appears you acquired it at around a six-type yield, is that correct?

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

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

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

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

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

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

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

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

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

Well you just covered half the world economies.

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

Let me make two general comments before passing it on to others for more specific details. The markets you mentioned, including Japan, the West Coast, and Florida, collectively represent significant parts of the global economy. We have two major land positions worth noting: one is Beacon Lakes in Florida, and the other is in Tracy, which is related to your question about the $76 per foot rate. The cost is low because the land in Tracy is essentially free; we have already recouped our total investment in that land. While the accounting perspective might differ slightly, the market value for the land in Tracy is about $30 per foot of Floor Area Ratio. Thus, it should ideally be valued at $100 per foot, but we secured a great deal on it, and we have an additional 800 acres without cost. Therefore, we can conduct a lot of business at very favorable land costs there. Beacon Lakes is not as striking in terms of size and land value advantage, but it is still significant. Those are the two large land assets we have. Would you like to discuss specifics?

To provide some additional insight, we have identified that our land bank in Mexico was larger than necessary, and we are actively reducing it. In Brazil, we have substantial land holdings, primarily through joint ventures, which means we are not burdened by holding costs. We anticipate significant profits from this land over the next five years, even though there hasn't been much activity recently. Regarding our construction projects, Hamid addressed this well. The low cost per square foot is influenced by two main factors: we have extensive operations underway at our park in Tracy, California, and we are currently focusing on a high proportion of build-to-suit projects. Build-to-suit developments are generally larger and come with lower values per square foot.

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

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

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

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

I would say that we are completely focused on build-a-suit projects. We're not expecting to maintain 100% build-a-suit for the entire year. I think we'll achieve around 15% to 16%, similar to last year. These projects are located across Slovakia, the Netherlands, Italy, and the U.K. To address the earlier question about our land positioning, it is indeed in the right areas. If you're doing 50% to 60% build-a-suit on owned land, your land has to be well positioned. Most of these projects are infill rather than bulk. Honestly, much of this relates to retail, including apparel, consumer goods, and there was even one in automotive.

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

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

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

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

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

Thank you. Hamid, could you elaborate on the term last mile? It has gained a lot of attention from investors in this sector over the past few quarters. Can you clarify what type of functionality and what demographics around a building would qualify as a facility that supports the delivery of packages to consumers?

The ideal market needs to have a large population, high income levels, a well-educated populace, strong Internet usage, and good connectivity. It should be densely populated and face some form of supply constraints, whether physical or political, due to the characteristics of the local residents. Based on these criteria, the top U.S. markets would likely include San Francisco, Seattle, New York, Miami, parts of Chicago, and Los Angeles. There are no strict guidelines regarding the size or number of stories of buildings, but newer developments will likely be multistory. Dock height access and smaller truck access may not be as crucial, but they should be near major roadways. Rent potential will vary significantly based on proximity to the market hub; a strong rent gradient is necessary, and some areas close to central hubs lack this due to their suburban nature. For instance, in Houston, despite being a large city, the spread-out nature limits effective last-mile delivery because it lacks the needed population density and supply constraints. These are essential criteria, and it's unfortunate that we often use the term "last touch" instead of "last mile." The last mile is really more about the last drive or a distance of about ten miles from the consumer, serving as the final step before reaching them directly. Many older properties marketed as last mile facilities often fail to meet these criteria, which we find amusing when we see these listings.

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

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

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

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

It's less than 5%.

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

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

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

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

Okay. It's me again.

I think it was worse.

They got the name right, so sticking with the old cynical view and not looking at the bright side of life, I'm curious how much we spend discussing the last mile as definitions have changed, and you mentioned multistory warehouses. I'm wondering how much of this is influenced by experiences in London compared to Asia. In Asia, it has been successful, but in London, it's seen more as a science experiment, especially with some properties near Heathrow facing issues with ramps. How do you address these challenges as you look toward potentially more builds of this nature in the U.S., based on your comments?

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

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

I believe those developers will manage well because they have some institutional funding, which is a traditional approach. If things go well, they will benefit from their equity interest and promote, and if not, they still have fee income to rely on for a while, while institutions, often pension funds through advisors, will end up seeing returns. Therefore, I don't anticipate significant distress since these deals are generally not heavily financed by banks but instead are more institutionally backed. I expect some investors may be disappointed with their returns, and hopefully, they won't support the next round of development funding. That’s how I see it unfolding. Can you please repeat the first part of your question?

Customer composition.

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

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

Yes, cap rates are stabilizing and decreasing because of the way capital is affecting them. However, we are not structuring our business around cap rate compression or expecting rents to grow significantly like they have been in the past. Our projections are based on stable or slightly increasing cap rates and modest rental growth, which can differ by market but generally falls within the 3% to 5% range in the U.S. The market rents for same-store properties will be somewhat higher due to mark-to-market adjustments. We are prepared to discuss these assumptions further, but our business strategy does not rely on an overly optimistic market moving forward. Our outlook is much more realistic.

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