Prologis, Inc.

Welcome to the Pelagis Q3 Earnings Conference Call. My name is Michelle, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. At that time, please limit yourself to one question. If you have a follow-up, please get back in the queue. Also note that this conference is being recorded. I would now like to turn the call over to Tracy Ward. Tracy, you may begin.

Thank you, Michelle. Good morning, everyone. Welcome to the Prologis Third Quarter Earnings Call. If you have not yet downloaded the press release, it's available on our website at prologis.com under Investor Relations. This morning, you'll hear from Tom Olinger, our Chief Financial Officer, and also joining us for the call is Hamid Moghadam, Gary Anderson, Chris Caton, Mike Curliss, Ed Neckert, Colleen McEwen, and Gene Riley. 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 the company operates, as well as the beliefs and assumptions of management. Both of these factors are referred to in Prologis' 10-K or SEC filings. Additional factors that could cause actual results to differ materially include but are not limited to the expected timing and likelihood of the completion of the transaction with IPT, including their ability to obtain the requisite approval of their stockholders and the risk that conditions to the closing of the transaction may not be satisfied. Forward-looking statements are not guarantees of performance, and actual operating results may differ. Finally, this call will contain financial measures such as FFO, EBITDA that are non-GAAP measures, and in accordance with Reg G, We have provided a reconciliation to those measures in our earnings package. With that, I'll turn the call over to Tom, and Tom, will you please begin?

Thanks, Tracy. Good morning, everyone, and thank you for joining our call today. We had another outstanding quarter. Customer sentiment remains positive, and we see no meaningful impact on our business from uncertainties surrounding trade. Our proprietary operating metrics reflect healthy demand, showing deal gestation conversion rates are positive, and in line with last quarter as our customers improve their supply chains in response to consumer demand for ever faster delivery times. U.S. market fundamentals are strong. I'd like to share our assessment of third quarter market statistics as we've seen more divergent viewpoints than normal. We've seen historically low vacancy in the mid-fours with supply and demand balanced at 75 million square feet each. Rents have outperformed, and as a result, we are raising our 2019 U.S. rent growth forecast from 6% to 7%, leading to an 80 basis point increase in our global rent forecast to 6.5%. Activity across Europe remains healthy. In the U.K., while overall demand is solid and our build-a-suit pipeline is very active, we are highlighting the Midlands as a supply risk. We continue to forecast 2019 rent growth on the continent to be the highest in more than a decade. Fundamentals in Japan are improving, with vacancy in Tokyo at less than 3% and Osaka at less than 6%, the lowest points in five years. From an operating standpoint, you will see that our quarterly results reflect our strategy of prioritizing rents over occupancy to maximize long-term lease economics. We leased 38 million square feet, including nearly 6 million square feet in our development portfolio. Quarter-end occupancy was 96.5%. down 30 basis points sequentially, and remains above our five-year average. Rent change on roll for the quarter hit an all-time high of 37%, led by the U.S. at 41.7%. Our share of cash seems to rely growth was 4.3% for the quarter, which was impacted by a 60 basis point reduction in average occupancy. Again, consistent with our strategy to push rents. Globally our insights to market rent spread widened by 40 basis points in the quarter and is now almost 15 and a half percent or over $400 million in nominal terms. Core FFO was 97 cents per share for the third quarter, which included 18 cents of net promote income from our Pell venture. The promote came in above our forecast as your valuations increased more than 2% in the third quarter. For deployment, Starts in the quarter were $577 million with an estimated margin of 22% and included about two-thirds billed to suits. The pace of starts will increase significantly in the fourth quarter. Stabilizations were $658 million with an estimated margin of 37% and value creation of over $242 million. We continue to access capital globally at very attractive terms. During the quarter, we issued $2.8 billion of debt, primarily in euro, at a weighted average fixed interest rate of under 1% and a weighted average term of more than 14 years. It's worth pointing out that we have an annual need for an incremental $600 million of non-dollar debt to naturally hedge our growing international assets. These issuances lowered our total weighted average interest rate by 10 basis points to 2.4% and lengthened our weighted average maturity by about two years to just under eight years. We continue to maintain significant investment capacity on the balance sheet with $11.7 billion of liquidity and potential fund sell-downs. In addition, there's an incremental $5.4 billion of existing third-party investment capacity in our ventures today. Guidance for 2020, which I know many of you are looking for, will be provided at our upcoming investor forum on November 5th. For 2019 guidance, I'll cover the highlights and then our share basis, and note this guidance does not include the positive impact of the IPT acquisition. We're increasing the bottom end of our cash-same-store NOI guidance by 25 basis points and now expect a range of 4.75% to 5%. We are raising the midpoint for development starts by $250 million and now expect starts to range between $2.2 and $2.5 billion. Build-A-Suce will comprise more than 40% of total starts, which is above our initial expectations. We are projecting $650 million of net deployment uses, which we plan to fund with free cash flow and debt. Net promote income for the full year is now expected to be $0.18 per share, an increase of $0.02 from our prior guidance. For the full year, we're increasing our 2019 core FFO guidance midpoint by 3 cents and narrowing the range to between $3.30 and $3.32 per share. At our revised midpoint, growth in core FFO per share excluding promotes is 10% higher than last year. Over the past five years, our growth has clearly been exceptional with a CAGR of almost 12% while de-levering from 27% to 18%. As I mentioned, this guidance excludes the acquisition of IPT, which we expect to close in January of 2020. We plan to split the $4 billion portfolio equally between our two U.S. vehicles. Private capital investor interest continues to be robust, as evidenced by the record fundraising in our ventures in the third quarter. Our pro rata investment will be approximately $1.3 billion, which we will fund with cash and debt. We continue to expect the annual core FFO accretion from IPT to range between 5 and 6 cents per share, or roughly 2% on a stabilized basis. The acquisition of this high-quality portfolio will capture significant revenue and cost synergies and deliver shareholder value on day one. To sum up, the third quarter was a continuation of what has already been an excellent year. I feel great about our outlook for the rest of the year and beyond. And with that, I'll turn it to Michelle for your questions.

At this time, if anybody would like to ask a question, please press star 1 on your telephone keypad. Again, that would be star 1 on your telephone keypad. Thank you. Your first question comes from Craig Mailman from KeyBank Capital Markets. Your line is open.

Hey, guys. Maybe I just want to hit here on demand and kind of where you guys have the availability in the portfolio. Could you guys just kind of talk through what you're seeing in the demand profiles between kind of larger and smaller tenants and your ability to push rents there and maybe improve credit quality? And then kind of talk a little bit about, you know, what you guys see as your ability to push the occupancy in, you know, under 100,000 or under 250,000 square foot space where you have more opportunity and maybe talk. Is there any more frictional vacancy in those type of spaces than in your bigger box? Or could we see those kind of spaces kind of narrow to where your average occupancy could be?

Now, that's a question. I know. That's a compound question. Did everybody write down? Anybody write down? Well, let me take a stab at this first, maybe talking about the smaller spaces. So, you know, these are spaces where we can push rents. And we're seeing pretty broad-based demand, frankly, across all sectors. But I think those are the smaller segment is where we can push rent growth. And I think if you look inside, you know, our rent change numbers, which are obviously at all-time highs, that would be the highest. In terms of the composition of the demand from an industry perspective, Again, that's pretty broad-based. Obviously, auto is weak almost no matter where you are in the globe. But otherwise, you know, we're still seeing pretty broad-based growth. We're seeing continued growth from the e-commerce sector, and that's probably a combination of reconfiguration of the supply chain as well as net demand.

So that's a start on it. Craig, this is Tom. So two of your questions. One on credit quality. Our credit quality continues to be exceptional. Our bad debt experience has been below 20% or 20 basis points of rent, below 20 basis points of rent for the last six years. It continues this quarter, so I feel great about our credit quality. And then just regarding your question on small spaces and frictional vacancy, we do have many more units in our smaller spaces, so naturally there's going to be more churn. in that, particularly as Gene pointed out, we're pushing rents. So you can see a little higher frictional vacancy, but the payoff is much higher rents. So the economics are clear to keep pushing rents.

Our next question will come from Jeremy Metz from BMO. Your line is open.

Hey, good morning. I mean, FedEx on its earnings call last month, they were citing more challenges ahead in 2020. They talked about, you know, the typical global trade disputes and concerns over economic slowing having created significant uncertainties. In your opening remarks, Tom did mention that you hadn't started to see that in your customer behavior yet. But clearly those risks are out there. So just wondering, has that surprised you at all that you really haven't seen it in the customer behavior yet? And then maybe just any broader thoughts on how this all impacts your outlook for development starts beyond the call of $2.3 billion you have underway in terms of cadence or desire to take on spec, et cetera. Thanks.

Sure. I think both statements can be true at the same time. FedEx cares more about flows, and obviously those become very volatile when it's trade wars one day and no trade wars the next day. And they have a very fixed cost basis infrastructure, you know, planes and trucks and all that. So, erratic volume cannot be good for them because they either miss the peaks or can't handle – either they can't handle the peaks or have too much capacity for the troughs. We're in the stock business. So, actually, uncertainty in the short term is extra demand for our space because when you don't know when that next – good is going to get to you because of tariffs or at what cost, you're going to carry more inventory and more stock closer to the customers. So I think FedEx is right as far as the metrics for their business are concerned, and I think the metrics for our business are just different.

The next question will come from Derek Johnson from Deutsche Bank. Your line is open.

Thank you. Hi, everyone. Can you discuss the leasing process for the multi-story facility in Seattle where Amazon and Target ultimately signed? And how competitive was this bidding process? How many interested parties did you have? And where did rents shake out versus underwriting? And what type of future demand do you anticipate? Thank you.

I would say the rents and the economics turned out better than our expectations. It took a little bit longer to lease up, but it leased up at higher rents. And the reason it took a bit longer to lease up is that nobody's ever seen a multi-story building before. So they wanted to look at it, lay out a lot of different configurations and make sure they could get the efficiencies out of it. So we couldn't be more pleased with the quality of the tenants or the financial performance of the asset. With respect to its implications, Look, for some reason, this building has gotten a lot of attention, and people think that there is a multi-story strategy. There is no multi-story strategy. The strategy is to provide space at places where our customers want it, which is increasingly close to their ultimate customers. The solution in some places is multi-story, and in other places is single-story. So, We're not in the business of building so many multi-story buildings. We're in the business of growing our infill position.

Your next question will come from Vikram Mahatra from Morgan Stanley. Your line is open.

Thanks for taking the question. So Blackstone just sold part of their original GLP acquisition. I was wondering if you looked at that portfolio and if you can just more broadly give us any sense of – any portfolios across regions and sort of how pricing or cap rates are shaking out?

Vikram, you can assume that we look at everything. People know our phone number and they know what business we're in. So we absolutely positively have never thought of a material transaction that we haven't seen. So you can assume we look at everything. I think the implications are you're going to have to ask Blackstone, but you know, obviously they bought that portfolio, and presumably they paid a pretty good price to get it, and presumably they sold it to these guys who must have presumably paid a really good price to get it that was attractive enough for Blackstone to sell it. So I can't be any more specific than that because I'm not in Blackstone's decision-making rooms, but those would be – those assumptions would be probably pretty fair.

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

Thank you. I want to get more of your thoughts on just the supply outlook. I mean, we do have, you know, historically high supply coming online, but you just said your development starts were 63% pre-leased in the quarter and you want to start more. You know, you expect to pick up in the fourth quarter. So can you kind of paint the big picture of how we should be thinking about the supply risk heading into 20? And as you think about your You know, do your development opportunities, the pre-lease percentage, and what gives you comfort at these, you know, this level of volume?

Hey, Jamie, hear me here. I think there's a lot of confusion about supply numbers. People mix supply, which is an annual concept, with what's under construction, which is a snapshot at a given point in time. So let me have Chris take you through those numbers because they're materially different as construction duration has lengthened.

Yeah, absolutely. Jamie, let's talk about three concepts. First, completions. Completions actually are on pace to be down this year by about 8%. When we look at a more real-time indicator like starts, starts are flat this year. Now, as Hamid mentioned, duration to build projects has gone up, and so we've seen under-construction rise. That time to deliver products has gone up by about a third in this cycle for all the challenges around supply that we've previously discussed. And so deliveries out of that pipeline now are much less than kind of 100% in a given following four quarters. So you've got to look at the time to deliver product to understand what deliveries will be in the following four quarters.

So basically, if you had the same level of supply, the same level of property under construction, you would have two-thirds the annual supply. if the trends of the recent past continue. So those two concepts need to be really kept apart.

Your next question comes from Blaine Heck from Wells Fargo. Your line is open.

Thanks, Hamid. In the press release, you pointed out the exceptional interest that you're seeing for your strategic capital ventures, and you guys have obviously done a great job raising money on that side of the business. Can you just talk about whether there are any specific groups that you're seeing incremental interest from? And then on the flip side, what do you think could cause that investor interest to decrease, I guess? Is there anything that kind of sticks out to you as a threat to that capital source in particular?

Yeah, the sources are pretty much from everywhere. I would say the U.S. pension funds are probably – flat to down compared to their, you know, call it 10-year type numbers. But Japan is up significantly. Generally, Asia is up significantly as these large institutions and sort of the pension system gets active on alternative investments. So it's everywhere. On the margin, I would say U.S. a little less and Asia a little bit more. With respect to the threats to that, it's the same old threat that we're seeing in every cycle. It's the denominator effect. If these guys are generally at today's investment levels under-allocated to real estate and alternatives generally and really under-allocated to industrial because it's a tough property type to access, But if the stock market goes down and the bond market goes down and the rest of the portfolio goes down, the same percentage allocation to real estate will have to go down, and that's usually been the cause of reductions in capital flows.

Did I answer that?

A minute. General question is from Keepin Kim from SunTrust. Your line is open.

Thanks. Good morning out there. Just two questions. I mean, what's your view on the potential impact from grocery e-commerce on the warehouse business and how PLD would potentially play a part? And second, just on lease spreads, obviously some really good numbers. Anything interesting about the mix of what rose this quarter that might be different going forward?

Yeah, I'd like to answer the second part. I think there are three things that drive the share of e-commerce in our portfolio or the space devoted to it. Number one is penetration, increasing penetration of e-commerce as a percentage of total sales, retail sales. That number is going up every year. And I think we'll go up for the foreseeable future as more categories become e-commerce friendly and and as, you know, the millennials, I guess they're not millennials, they're generation Zers, who grew up with an iPhone start entering their prime shopping years. So, you know, the iPhone, I think, is 11 years old and, you know, 12-year-olds who are now graduating from college or 11-year-olds who are graduating from college basically have never known the world without an iPhone and e-commerce. So I think it's As those guys enter the population, the spending part of the population, I think the percentage will go up. And then there's the old 3x factor of space that e-commerce takes, which, well, on top of the gain share of e-commerce and underlying retail growth, which is probably the slowest of the three factors, you know, maybe 2% type thing. All those three factors combined, should make for a really good environment for e-commerce demands over time. Now, the real strategic question is, how does automation affect the 3X factor? Does it reduce it? Does it expand it? The answer on that is unclear at the moment. And in certain instances, it increases significantly. the need for real estate, and in certain cases, it reduces the need for real estate. But one area that for sure over time will get more efficient is the returns business. And, you know, returns are really caused by free shipping and free returns and all that sort of thing. And over time, I think FIT and issues like that will get better. So I would guess that part of the demand in warehouse space will go down. Anyway, the biggest, biggest strategic driver of all this, long-term secular driver of all this, is the need for speed and choice. Because the more choices you want and the quicker you want them, the more inventory you need to position near the customer. So that's all really good for our business.

Kevin, this is Tom on your question about rent change for the quarter. We did see a higher mix this quarter in the west and east regions, so the coastal markets of the U.S. That being said, almost every region had its all-time high or near its all-time high in rent change. So we're seeing very positive rent change across the board, almost without exception. You ask about a trend, our four-quarter trailing average rent change is right at 28%. this quarter, I think that's a pretty good outlook in the near term for where rent change should be. But remember, when we talk about in place to market at being 15.5% below market, that means rents need to grow 18.3% to get to market, right? So if you're 15.5% under rented, you need to grow by 18.3%. That's just math to get to market rents. So think about our in-place built-in rent change at being 18.3%, and think about what's rolling. Near-term is obviously signed further ago, so naturally our rent change would be higher in the near-term. And the last thing I'd point out is rent change. The rent change on the roll, that four-quarter average, we're now at 28%. That's up 600 basis points in the last year. So we've seen that number move up. I think we can hang around there based on our in-place-to-market.

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

Thank you. Just two quick questions. One's related to portfolio sales. It's based on the black information, black activity. Do you see any meaningful differences between portfolio sale prices versus smaller transactions you guys might pursue? And then second, just on the demand front, there's a lot of press kind of given to smaller buildings and multi-tenant leasing. My conclusion is that that kind of leasing and the rent growth you can get is really more dependent on location than property size. Can you affirm whether that's true or not, or is a smaller building in some Midwest market getting record rent growth as well? Thank you.

Eric, let me jump in the middle of that before Gene starts on the first part. The The most important thing with respect to rent growth is location in terms of macro market and the micro sub-market. By far, more important than tenant size and all the stuff we talked about before. So you're spot on in that one, and those are the scarcest properties. James, do you want to answer?

Yeah. Eric, with respect to the portfolios, I mean, as Amin mentioned, of course, we look at all these things. We price them. And for sure, lately, portfolios are selling at what we consider a premium to the sum of the parts. So I think that is true. Having said that, you know, there's also plenty of one-off transactions and very, very good markets that have pretty stunning metrics associated with them.

Your next question comes from Caitlin Burrows from Goldman Sachs. Your line is open.

Hi there. I was just wondering maybe on the development side, the total development portfolio declined slightly since last quarter, but the 2019 starts are actually up. So is this just a function of pulling forward previously expected activity? And what's your confidence in being able to sustain that level of starts going forward as Prologis grows? And then just on the yield side, those have come in a little, I think, from about 6.5% to 6.1%. So What's driving this, and could that increase back up?

Yeah, on the second point, that's really basically a mix. But having said that, you have generally seen cap rates declining, frankly, over the last, well, probably for 20 years. But over the last couple of years, cap rates have been declining, and you will see some, you know, change in the returns on costs as well. In terms of the development volumes, you know, what we're implying is a big fourth quarter, about a billion two. But I think that's about right on top of what we did in the fourth quarter of last year. We're highly confident of that. And in terms of the future beyond that, you know, we'll talk about that when we give guidance.

Yeah, and this reminds me of a previous question that I don't think I answered, which is, what's our attitude towards spec development? And I would say the bar on spec development has been high and continues to be pretty high. And, you know, you can see the results of that in the built-to-suit percentage being a lot higher.

Your next question comes from Manny Karchman from Citi. Your line is open.

Hey, good morning, everyone. Tom, just thinking about your occupancy guidance, your retention in the quarter was actually higher than the trailing few. And yet you commented in the press release that you're focusing on rent growth versus occupancy. So does that mean that new leases aren't happening as fast as you thought? And is that because of rent levels? Or is there something else that's sort of not connecting between retention rates and occupancy?

So this is not Tom, but I'll answer your question. The retention ratio, you're dealing with tenants that are already in the space, and today labor is a huge issue for people. And every time they move, they have to go hire a bunch of people because now the workers have choice and they're not going to change their commuting patterns, et cetera, et cetera. So customers that are in existing space have a much higher propensity to stay regardless of almost rent, which is an afterthought for a lot of them. So where you see the effect, the primary effect of pushing rent is on capture of new leasing in the developments. That's where you're likely to see it the most, and that, of course, doesn't affect the retention numbers that we report.

The next question will come from Nick Uliko from Scotiabank. Your line is open.

Thanks. I just had a question on the leasing spreads. I know you, Tommy, gave some info on what drove it higher, this core. I just want to make sure as well, though, that, you know, the switch to the clear leases in the past year, has that had any impact on the way you guys measure the releasing spread?

No impact at all.

Our next question will come from Michael Carroll. From RBC Capital Markets, your line is open.

Yeah, I just want to follow up on the, I guess, PLE stance on pushing rents over occupancy. Hasn't this been your stance over the past few years, or are you just being more aggressive today? And is that a good, fair way to say what's being reflected in the lease spreads and how they're pretty much doubled than what they were for the trailing four quarters?

It's been our state's objective to do this for previous quarters, but there are these messy things called human beings and people in the field that have to need to change their mindset, and that took a couple of years to really get that going. We track why we lose tenants when we don't renew somebody, and we've tracked them for a long, long time. And I'm not kidding you, but there were years that we had literally zero tenants leaving because of rent. on renewals, literally. So that number is no longer zero, but it's a lot lower than I think it should be, or I would have expected it to be.

Your next question comes from Steve Sacklaw from Evercore. Your line is open.

Thanks. I just wanted to clarify, when you talked about the, and you and Chris talked about sort of the construction pipeline or time to build getting longer, You know, is that nine months to 12 months, or is that more of a 12-month to now 16-month? Just trying to understand that. And then are there any markets in the U.S.? You didn't really call anything out, but just trying to get a sense. Are there markets in the U.S. that you're a bit more worried about or really just seeing much less rent growth today?

Yeah, by the way, on the duration of construction, it depends on where. In Japan, they were 16 months, and I don't know what they are today, but It takes longer to build a multi-story building. But let's focus just on a single-story U.S.-style warehouse. I think Chris has the numbers for you.

Yeah. Hey, Steve, it's going from eight to nine months to something more than a year. Call it 13, 14 months. What I think we will see is that deliveries over the next four quarters can be roughly 75% of the under-construction pipeline. That's how we see the numbers coming together. As it relates to markets, we talked about how we, on the last call, how we haven't added any markets to our supply risk list. That remains the case today. And, in fact, a market like Chicago comes off that list this quarter.

Yeah, and Osaka came off a little bit earlier.

Yeah, Osaka is a market that came off. And then on that list include Atlanta, Pennsylvania, Houston, Spain, and the Midlands was covered in Tom's script.

I would say the one that I would point out as being more at risk today than last quarter, even though it was on the list, is Houston. There is a lot of space under construction in Houston, and I think some people are going to get surprised. And some of it is not in the best sub-market. So some of the outlying sub-markets in Houston you need to watch. Fortunately, we're not exposed to those submarkets.

Next question will come from John Gunny from Stifel. Your line is open.

Great. I think Mike Curliss is in the room. I was just looking at page 24, and I noticed an uptick in a pretty sizable land acquisition year to date and also acquisitions in other investments in real estate. Can you walk through, Mike, where you're buying the dirt and also what the other investments in real estate might be?

Probably Gene should answer that question since Mike has a new job, but Gene, go ahead.

Yeah, and Mike can maybe offer a customer color where they want the dirt. But, John, where we generally need to replace dirt is in the coastal markets where we've done a lot of development, absorbed a lot of the land bank. So there's a piece in L.A. included in that. But as we look out going forward, replacing land is very, very expensive these days. As you know, we've done a lot of work to work this land back down to what we consider a manageable level. As we replace land going forward, we're trying to do it creatively. We're trying to tie up land through options. But it's going to be more expensive. And, you know, we'll see the – the land bank pick up a little bit, but we're going to remain very disciplined on that front as we have been.

Our biggest needs for land, I would say, are Southern California. We're good in Seattle, we're good in the Bay Area. Southern California, we need more land. Chicago, we need more land. And I would say New Jersey, we need more land for sure. Those are the top three that I would call it.

And with respect to the customers, where they want to be, two, three years ago, 80% of our land that we're doing build-a-suits in were in global markets. Those numbers are closer to 95% these days. And, John, your question about the other investments, just think about those as being covered land plays.

Not land, but will become land soon. Yeah, those are actually yielding probably pretty close to the local market cap rate, maybe a tad below, maybe 20, 25 basis points below, but they're basically covered land place.

The next question comes from Michael Mueller from J.P. Morgan. Your line is open.

Yeah, hi. I was wondering, do you expect the elevated mix of build-to-suits to be a little bit more of the norm over the next year or so?

As Mike said, we did have a robust quarter at almost two-thirds billed pursuits. If you look across the year, that's blending in in the high 30s, and I'd expect numbers to be in the low 40s as we look forward. I think this was an unusually high quarter, but directionally indicative of how important the billed pursuit part of the business is to us these days.

You know, compared to five or ten years ago or 15 years ago, I mean, that number would have been 20%, 25%. So I think the tightness of the markets is forcing the built-to-suit percentage up.

And your next question will come from Craig Mailman from KeyBank Capital Markets. Your line is open.

Hey, guys. Just want to kind of hit on kind of your liquidity here and the funds and on balance sheet. Your cost of capital is clearly advantageous, but you have a lot of kind of well-heeled competitors as well. I'm just kind of curious. You guys look at the acquisition landscape. You've been successful in some, missed some others. But just kind of how you look at return requirements for on-balance sheet acquisitions here versus the in-funds. And just talk a little about what you're seeing on the quality spectrum of portfolios that have traded or may be out there and kind of interest level.

Let me start that and, Gene, jump in if you'd like. I think the pricing for quality differences is getting compressed. In other words, cap rates for lower quality, lower growth assets are compressing against high quality assets on location. And that always happens in this part of the cycle. People are really anxious to get into this asset class. And You know, if it's industrial, it's industrial, and they become less discriminating over time. Also, if you're a leveraged buyer and you're really looking at locking in the cost of capital, debt capital today, and you employ a lot of it, obviously this is a really good environment for your buying things and financing them. With respect to the way we look at our unleveraged WACO, our cost of capital, I would say we look at that every quarter or so, and we occasionally, and only in a very limited way, have dropped our requirements. I would say for a U.S. high-quality portfolio, probably a six IRR would be the right number today, very high-quality portfolio for us, and, you know, take it up from there. But unfortunately, some stuff in the marketplace is even for low-quality assets, is getting priced too tighter than that. Now, a 6 IRR in a 1.6 or 7% 10-year environment is pretty attractive. I mean, those are some of the widest spreads I've seen in my career. And so, yeah, the absolute numbers sound low, but in relation to cost of capital or debt cost of capital, they're actually pretty attractive.

Your next question comes from Vikram Malhotra from Morgan Stanley. Your line is open.

Thanks. Just wanted to follow up on two things. One for Chris. You mentioned sort of some of the rent growth, and obviously it's different by sub-markets. I'm wondering if you're starting to see any divergence from recent trends, you know, in sub-markets within MSAs, meaning more divergence than what you've seen recently in And then just one for Tom on the clear leases. Wondering how that's, if any, impact on the expense side and if it may be positively or negatively impacting NOI growth.

Yeah, hey, as it relates to rent growth, a couple ways to look at that. One is we continue to see that divergence between infill and non-infill, as Hamid was discussing earlier in terms of sub-market strategy. As it relates to markets, we've seen better – outperformance in the east, in New York and in Toronto, for example. And we continue to see really good growth in Europe, much like we telegraphed last year and the year before. And what you see there is some of the early recovery markets continuing to outperform, whether that's Germany or the Netherlands or Czech Republic, and some late recovery markets really starting to pop. France comes to mind. So that's how the rents are trending. Great.

Vikram, on your question around the clear leasing expenses, those leases are set up where we fix all the costs for real estate taxes. The tenant bears that. And we are collecting slightly more on the expense reimbursements right now. But essentially call it even. So we set it up that way to be expense neutral. So no impact on NOI. And to go back to Nick's question, just in a clear lease, and did that have any impact on how we're calculating rent change? It does not. That clear lease is, think about it, simply having a rent component and an expense reimbursement component. And the rent change is calculated on the revenue, the rent component, not the expense component. So, no impact.

Yeah, I just want to clarify something, Tom. We actually don't collect reimbursements. That's why it's a clear lease. But we do track what it would have been under a triple net lease. And actually, for the last year and a half or two that we've been implementing this, The numbers have been remarkably on top of one another, and that's the advantage of having, I don't know, an 800 million square foot portfolio to spread this stuff around.

And your next question will come from Manny Corchman from Citi. Your line is open.

So, Hamid, I had a follow-up on my previous question, and I have a new one for you guys. So you mentioned, you know, leasing is development. I guess that wouldn't impact your occupancy guidance. So just going back to that, in isolation, if retention is where you expect it to be at 81% and you've lowered your occupancy guidance, that means that your case of lease-up in already vacated space or space to be vacated is going to be slower. Is that the wrong way through?

We are – Remember the part that I said that in the years we had zero people that we were losing as part of a renewal discussion? That number is not zero, but it's not as high as I would like it to be. You were also talking about occupancy declines from 98%, and I've been doing this for 37 years. There was only one year where we were in the 98% range, and I said, guys, don't get used to this. We're going to push this number down. So I think we were very clear on what our strategy was, and I would say we've executed it exactly the way we described it.

The next question comes from Jimmy Seltzman from Bank of America. Merrill Lynch, your line is open.

Thanks. I was just hoping you could explain more why developments are taking so much longer to deliver. And then also, just thinking about the TI number in the quarter and what we've seen this year, I mean, are you spending more on leases, on TIs on leases? And if so, can you explain what those, you know, why that's happening and what that's going to? And is that impacting your ability to push rents as well?

Jamie, I'll take the first one. It's Gene. It's basically a combination of construction timeframe and there's some entitlement issues timeframe in that as well, which, by the way, can affect a project through its construction as you pull secondary permits as you go forward. So it's really those two items. And, of course, depending on where you are geographically, there's a pretty wide range of outcomes.

We've also had kind of weird weather patterns that I think most of you have noticed. That definitely messes with construction schedules.

Jamie, on your second question on the turnover costs, it's a little higher this quarter. I think it's due to two things. It's mix in timing. But I'd go back and look at what we've been on a trailing four quarter. I think that's a better representation. We have been coming down pretty clearly over the last – on a trailing four quarter basis over the last really three years. And that makes sense just given concessions are falling across the board. The other thing I'd point to is look at free rent as a percent. of lease value, that is consistently declining again. So I think overall, this quarter's mix and a little bit of timing, it's not impacting our – we're not trying to buy rent change, if that's the question.

And your next question comes from Steve Sakwa from Evercore, your line is open.

Thanks. Hamid, I was just wondering if you could provide an update on sort of the big data initiatives and the procurement and sort of where you stand and, you know, is that something we're likely to get a lot more detail on for 2020?

On the big data, we are, as I mentioned to you, tackling one very specific project, which is yield management. And I would say that's going really well. We're piloting in four markets and we'll be expanding that to the portfolio in and we're encouraged by the early results. I don't know. Chris may have more to say about that. Gary, you want to talk about the other initiatives?

Yeah, on the procurement initiatives, we stood up that procurement organizations we've talked about in the past, and things are going well there, I'd say, both in terms of procuring construction-related items and CAPEX and GNA. So that is off and running. And with respect to the revenue side of the equation, I'd say that we're off to a good start. We're starting to build that business. We're probably getting into the tens of millions of dollars in terms of revenue, so it is becoming more meaningful, and we're seeing roughly double-digit growth.

Yeah, I would say that that business today, if you isolate it, would be pennies a share of incremental earnings. I think in two to three years it will be dimes, and we're hoping that its potential is more than a dollar. But that is going to take us a while to get to. So don't put in the dollars. Don't put in the taxes. Put in a couple of pennies that we're talking about right now. We're doing better than that, actually. But it's a slow ramp. Nobody's done this before. So we need to educate ourselves and our customers and a lot of other people to get this done. I think, Steve, you were the last person. So thank you all for your interest in the company and I want to put in a big plug for our analyst day, which is coming up, and that's why we've saved all the good guidance stuff for that day to encourage you to come. Take care.

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