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spk09: Welcome to the Prologis Q3 earnings conference call. My name is Carol, and I'll be your operator for today's call. At this time, all participant lines are in a listen-only mode. Later, we will conduct a question and answer session. To ask a question during the session, you'll need to press star 1 on your telephone. Also note, this conference is being recorded. I'd now like to turn the call over to Tracy Ward, Senior Vice President of Investor Relations. Tracy, you may begin.
spk08: Thanks, Carol, and good morning, everyone. Welcome to our third quarter 2020 earnings conference call. The supplemental document is available on our website at Prologis.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 which Collagis operates, as well as management's beliefs and assumptions. Forward-looking statements are not guarantees of performance, and actual operating results may be affected by a variety of factors. For a list of those factors, please refer to the forward-looking statement notice in our 10-K or SEC filings. Additionally, our third quarter 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. This morning, we'll hear from Tom Olinger, our CFO, who will cover results, real-time market conditions, and guidance. Hamid Moghadam. Gary Anderson, Chris Caton, Mike Perlis, Ed Neckliff, Jean Riley, and Colleen McEwen are also here with us today. And with that, it's my pleasure to turn the call over to Tom. Tom, will you please begin?
spk12: Thanks, Tracy. Good morning, everyone, and thank you for joining our call today. Our third quarter results were strong as the team on the ground executed extremely well in this COVID environment, demonstrated by our operating performance and robust capital deployment activity. Our results, plus continued improvement in market conditions, have upgraded our outlook. Starting with our view of the markets, our proprietary data reveals that operating conditions are meaningfully better than they were 90 days ago, and as a result, our earnings are now ahead of pre-COVID levels. The Fawadj's IBI Activity Index rebounded sharply to more than 59 in September, above our long-term average, and up from 50 in June. Space utilization, which is based solely on data source from our customers, was 84% at quarter end and indicates our properties are returning to near peak capacity. On a size-adjusted basis, lease signings were up 31% in the third quarter and up 4% year-to-date. Customers continue to make decisions faster than ever with lease gestation less than 50 days. Proposals remain at healthy levels, up 3% sequentially and up 12% on a year-to-date basis. This positive momentum has led us to raise our market forecast. For 2020 in the U.S., we now estimate net absorption of 210 million square feet and completions of 295 million square feet, each up approximately 50 million square feet from our prior forecast. Net absorption in the quarter was robust at 65 million square feet, pointing to a very healthy finish to the year. We've also upgraded our year-end vacancy forecast for Europe and Japan to 4.3% and 1.3% respectively. Notably, vacancy in Tokyo reached an all-time low of 50 basis points, and rents are growing as a result. As we look to space size, demand broadened across segments this quarter to include 100,000 square feet and above. Space is under 100,000 square feet in several markets, notably the San Francisco Bay Area, have lagged the other segment sizes in both occupancy and market rank growth. For customer segments, demand is also broadening and diversifying in our portfolio. E-commerce continues to grow, representing 37% of the new leasing in the quarter, well above its historical average of 21%. The dramatic structural shift to online shopping is generating demand in three ways. First, a wide range of omnichannel and pure online retailers are growing. And while Amazon is very active, particularly with build-a-suits, they represented just 13% of our new leasing. Second, 3PLs represented more than a third of new e-commerce leasing in the quarter, a record as customers race to augment their fulfillment networks. And third, many of the parcel carriers are also expanding their networks. Our other segments represented 63% of new leasing in the quarter. The most active segments support essential industries, including food and beverage, health care, and consumer products. Another new emerging structural driver is the need for resilient supply chains and higher inventory levels. Inventory-to-sales has fallen to the lowest levels on record, and many customers are operating with razor-thin inventories. We see signs that restocking process has begun. Moving to our results, we had a strong third quarter with core FFO per share of 90 cents. We outperformed our forecast due to higher NLI strategic capital revenue and termination fees partially offset by slightly higher GNA. Rent change on rollover continues to be strong at 25.9% and led by the U.S. at 30.7%. Rent collections remain ahead of 2019 levels. As of this morning, we've collected over 99% of third quarter rents and over 94% of October rents. In addition, we've received 95% of deferred rents due to date. Bad debt is trending lower than forecast and was 43 basis points of rental revenues in the quarter. This was roughly half of what we had forecasted. Our share of cash same-store and allied growth was 2.2%, despite the impact from lower occupancy and bad debt. This speaks to the underlying strength of our rent change, the primary driver of same-store growth in the quarter and the long term. Looking to the balance sheet, we continue to maintain exceptional financial strength with liquidity and combined leverage capacity between Prologis and our open-ended vehicles totaling more than $13 billion. We also continue to refinance debt opportunistically, setting records in the quarter for the lowest REIT and third lowest U.S. investment grade 10 and 30-year coupons in history. For strategic capital, investor demand is unabated. Our team raised over $800 million of new equity this quarter, and the queues in our open-ended vehicles currently stand at $2.6 billion. Turning to guidance for 2020, our outlook continues to improve given what we see in our proprietary data, our customer dialogue, and lower bad debt. While there may be headwinds until we put COVID behind us, our revised guidance range has taken that into account. Here are the key components of significant guidance changes on an R-share basis. We're narrowing our cash change to an OI range between 2.75% and 3.25%. At the midpoint, this assumes a 25 basis point reduction of bad debt, with a new range between 45 and 55 basis points of gross revenues. Globally, market rents grew in the quarter, and we now expect growth of 2% for the year, approximately 250 basis points ahead of our prior forecasts. After prioritizing occupancy for most of the year, we've resumed pushing rents in a handful of leading markets, including New Jersey, Pennsylvania, Southern California, Dallas, and Northern Europe, as well as a few regional markets. On the other hand, we're still salving for occupancy in Houston, Denver, West China, and Madrid. Our in-place market rent spread now stands at over 12% and represents future incremental organic NY growth potential of approximately $450 million annually. For strategic capital, we expect revenue excluding promotes to range between $380 to $385 million. The revenue growth for our business has been excellent, with a five-year revenue taker excluding promotes of over 16%. The vast majority of this revenue is derived from recurring asset management fees from our perpetual or long-life vehicles. When we look at multiples being ascribed to this business, our view is that they are far too low. For comparison, public asset managers are valued at a multiple of more than 20X on far less sticky AUM with much higher promotes. For development, we expect to start $1.1 billion in the fourth quarter, with the full year ranging between $1.6 and $2 billion, up $800 million from our prior forecast. Build assumes we'll remain elevated and comprise about 45% of the annual volume. In addition, by year end, we expect to restart about $180 million or approximately half of the development projects we suspended in the first quarter. At the midpoint, we're increasing both contributions and dispositions by $350 million. Based on our third quarter valuations and current market activity, pricing for our properties is now pushing well beyond pre-COVID levels. Taking these assumptions into account, we are narrowing our range and increasing our 2020 core FFO midpoint by 4.5 cents to $3.76 to $3.78 per share. This includes 21 cents of net promote income, which is up a penny from our prior guidance. Year-to-date growth of the midpoint excluding promotes is 13.7% while keeping leverage flat. Interestingly, while there's been a lot of noise over the past seven months since the beginning of the pandemic, The net of it is we're ahead of our pre-COVID earnings expectations today. In closing, our performance is a testament to the foundation we've been building for more than a decade. Our three-year earnings figure of 11% has outperformed the other logistics rates by more than 500 basis points annually, despite a greater relative decline in leverage. The work that we've done to create the best-in-class portfolio and balance sheet is clearly paying off. The business is proving to be incredibly resilient and is delivering exceptional growth which we expect to continue. With that, I'll turn it back to the operator for your questions.
spk09: Thank you. As a reminder, if you would like to ask a question, please press star followed by the number one on your telephone keypad. Our first question comes from Emmanuel Quarchman from Citigroup. Please go ahead.
spk18: Hey, everyone. Good morning and afternoon out there. Tom, just in terms of collections, they're obviously strong and they continue to be strong, but there is a downward trend. Is there anything specific in those numbers that we should be mindful of or anything that you think might drive a quicker recovery there than we're looking for?
spk12: Yeah, Manny, collections have been excellent. Actually, there's no downward trend. If anything, they're trending up. If you looked at our collections today, we're at over 94% this morning when we had our call in Q2. July collections were at 92%. So we're 200 basis points plus ahead of where we were comparably. We're ahead of 2019 levels across the board. And I think collections are actually accelerating a bit from the last quarter. So I'm very, very pleased with where collections are.
spk09: Our next question comes from Derek Johnston from Deutsche Bank. Please go ahead.
spk13: Hi, everyone. So lease spreads continue to be robust even as we progress through COVID-19. How do you view the pandemic's impact on the portfolio in terms of rent growth? So when you look at the overall portfolio, do you believe you could have pushed rents harder without the pandemic, or has the pandemic perhaps curtailed rent growth? And then lastly, do current rent trends have legs in your opinion? Thank you.
spk18: Hi, Derek. It's a good question and one that we ask ourselves often. But there's no going back and sort of playing that hand again because, you know, when you're looking at, you're sitting there in March and looking at what could happen, you make certain decisions. I think generally we could have pushed rents harder had we known how this was going to play out. But, of course, we didn't. I think that is gas in the tank for the next 12 months. So I'm pretty optimistic about our ability to continue to grow rents. And, you know, we turn over 15%, 16% a year. So if we were a quarter or two late on pushing rents by a little bit, by the time you work through that 15% and a little bit of rent growth change, the numbers become minuscule in terms of what we may have missed. But whatever that was, I think is fuel. for future growth.
spk09: Our next question comes from John Kim from BMO. Please go ahead.
spk04: Thanks. Good morning. This quarter, you had sequential occupancy declines of 200 basis points in both Chicago and Houston. I'm assuming this is based on new supply, but just wondering about the case. And also, are there other markets where you're concerned from a supply perspective?
spk17: Yeah, it's Gene. I'll take that. Others may pile on. Houston, for sure, is going to face headwinds. There's a ton of supply in that market. You guys know the story there. Chicago, we feel a little bit better about. Actually, that market's fairly strong. And elsewhere in the U.S., from a supply perspective, things actually look pretty good. You know, we have seen... in this quarter a significant increase in absorption and a corresponding increase in supply, but we're dealing with very low vacancy rates across the board. So we actually feel pretty good, and in the U.S., Houston would be the concern on supply at this point.
spk09: Our next question comes from Jamie Feldman from Bank of America. Please go ahead.
spk10: Thank you. Tommy, you talked about $13 billion or so of liquidity. Can you help us understand or just think through if there's any opportunistic acquisitions out there where you might be able to put some of that capital to work over the near term?
spk12: Thanks, Jamie. Listen, I think the key for us is for an opportunity, it's going to have to expand our growth potential, and when those things occur, It's hard to determine, but we're always ready. We always maintain significant liquidity, so when the time is right, we're ready to go. But we're certainly not seeing large portfolios on the market these days. The pricing for our product is going to be well above where we were pre-COVID, so there's a lot of interest for product.
spk09: Our next question comes from Blaine Hack from Wells Fargo. Please go ahead.
spk02: Great, thanks. Tom, you noted that you guys are assuming starts of a little bit more than a billion dollars at your share in the fourth quarter. Can you guys just talk about how much of those are built suit versus spec and whether this is just pent-up demand from clients that didn't want to pull the trigger earlier in the pandemic, or what else is kind of driving your confidence to start that much in the fourth quarter?
spk17: I'll start with that question. I'll kick it over to Mike. But it's probably good to talk about spec development overall and what our picture looks like. So as a reminder, we suspended 16 projects in the spring in 18 markets, and that was almost $400 million of activity. And through last quarter and what we expect in the fourth quarter, we'll restart projects. 10 of those projects and about half that volume. So we're generally positive on speculative development. And if you look at the next quarter, we will start more spec projects, somewhat less than we would have anticipated in January, but pretty close to those volumes. So we will be down slightly. with respect to spec development during 2020 versus the January forecast were actually up significantly with respect to the build-a-suit volumes. So that's where it's coming. And, Mike, you probably have some color on that.
spk16: Yeah, Blaine, let me add to that. We saw a really strong Q3 in terms of build-a-suits, particularly in Europe with six project starts there across Europe. a diverse set of customers. And our overall prospect list, you heard us say this last time, is probably a little bit shorter than it's been in the past, but the prospects on that list are as active and moving as quickly as we've seen in a long time. In fact, never seen anything quite at the pace. And, of course, Amazon is a big part of that, but certainly not all of it. And There's quite a bit of activity in the structural changes that were announced by the home improvements, the food customers pre-COVID that they're now acting on at a quicker pace than even anticipated. So very confident in the diversity of our Build-A-Suit pipeline and the strength of it. So we're optimistic for the fourth quarter.
spk09: Our next question comes from Nick Helico from Scotiabank. Please go ahead.
spk15: Good morning. This is Sumit for Nick. Thank you guys for putting together some great research on the retail conversion opportunity. I guess I'm interested if you could share your insights regarding why the freestanding retail component that you guys estimate at 40 million square feet of conversions or 50 bits to 150 bits of your market share is Why is it so little when these are located in more densely trafficked routes as well as have more supportive parcel sizes? I think one of the developments in the Bronx is built over a two acre lot, which is far less than the five to six acres that is typically required. So shouldn't this support more conversions across other areas? Honestly, putting full conversions aside, what drives your conviction that tenants could actually just plain lease up these boxes or other non-performing shopping centers for smaller delivery operations? Any color, any insights from your tenants would be great.
spk14: Hey, Sumit, it's Chris Caden. Thanks for the question. First, for those who aren't familiar with what he's talking about, Pelagius Research published a paper on pelagius.com. We sized the retail to logistics trend. We estimated it being 5 to 10 million square feet per year over the next decade. And this amounts to really a small part of our overall business, less than 5% of last touch, less than 1% of existing logistics real estate facilities for a lot of reasons. So Suman focused on the freestanding retail. That is, in fact, the largest category, and so that is where we expect to see the most retail. conversion opportunities. But look, the challenges are many and varied in terms of conversion trends, whether it's physical and the ability simply to use the site, whether it's economic and rents versus development costs and higher and better use opportunities, whether it's local politics or whether it's just the legal situation at the site.
spk18: Yeah, the other thing I would add to that is that in freestanding retail by and large is a more western and southern phenomenon because by definition those cities are less dense. And actually that's kind of not where you want to have freestanding and last touch retail. You want to have it in dense metro areas. And if somebody's got a retail box in that metro area, they're likely to be doing pretty well with retail on it anyway. So it's sort of a catch-22 that places where you can find these boxes are are not the places that there is heavy-duty last-touch type of demand. The trick is getting the availability and the demand picture in the same spot.
spk09: Our next question comes from Vikram Malhotra from Morgan Stanley. Please go ahead.
spk15: Thanks for taking the question. Just to build off the question on leasing spreads, you alluded to the fact that you've sort of extended the trajectory into next year. I'm just wondering if you can give us your updated thoughts on actual market rent growth in some of the key areas in the U.S., but also maybe in some of the global markets. Just wondering if all the factors you laid out has potentially accelerated that trend as well into 21 in terms of actual market rent growth. Thanks.
spk14: Hey, Vikram, thanks for the question. So as Tom shared in his remarks, global rent growth is on pace for 2% this year on Pelagia's share basis, higher than that in the U.S., roughly flat in Europe and the U.S., and better than that, called 1% in Japan. That's a good number for Japan. Now, what that looks like in 2021, we don't disclose the numbers, but what I do think about are the headwinds and tailwinds for our business. And to an earlier question, these trends suggest an improving trajectory for rent growth. You know, when I think about the positives for our business, I think about low vacancy in a lot of markets. around the world. The structural drivers that Tom outlined in his script are really revealing themselves, both e-commerce and inventory levels. We've seen positive momentum in the third quarter and solid proprietary data. And there is this potential decline in COVID uncertainty, COVID economic weakness. You've got to set that against the lack of clarity on COVID and some of the challenges that are intended with a recession that will play out in 2021.
spk18: Yeah, but in terms of implications of rent growth on earnings, I mean, basically rent growth globally this year is a little over 2% and probably 2.5% in the U.S. Unless something really strange happens, I expect that number to be pointed up. Now, how much up in the last five or six years, we've always underestimated rental growth. So I don't know. But the primary driver of earnings growth is going to be mark-to-market anyway, whether on the margin rents grow 3% or 4% or 5%. That incremental amount, at least for the next year or two, is not a big determinant of earnings growth. So I'm not trying to duck your question. I'm just given the kind of small changes we're talking about here, I don't think the earnings implications are significant.
spk09: Our next question comes from Steve Sackwell from Evercore ISI. Please go ahead.
spk01: Thanks. Just two quick questions here. Tom, I guess you pretty much raised all the metrics in the press release with the exception of same-store NOI growth, but you took your bad debt expenses down again this quarter. Is the headwind here just some short-term issues on occupancy, number one, And then I guess just as it relates to development, Hamid, to the extent that the e-commerce trend does continue and it looks like it's going to continue to go up towards probably the mid-20s, you know, how long and sustainable do you think the development pipeline can stay over $2 billion given the, you know, it seems like the growing demand pipeline you've got from not just e-commerce, you know, but other categories that Tom mentioned?
spk12: Hey, Steve, I'll take your first question. So we've What's happening with cash, same store, it's flat at the midpoint, and it's all timing because we have significantly high leasing in both the second and third quarter, and new leasing was significantly higher. And as a result, what you're seeing is free rent from all of those lease commencements really hitting Q4. So that's a little bit of a danger of using cash. same store here is because of that free rent. It's just kind of hitting in Q4. You'll note that GAAP, same store, went up 25 basis points, commensurate with that debt. So it's really a timing issue from that initial drag. On cash, same store from free rent.
spk18: I think with respect to the legs of e-commerce and their effect on development going forward, I would still say we're in the very early innings of that in the long term. And I think as long as we're in COVID, the growth rate in e-commerce is going to be very, very significant. But as we come off of COVID, I expect that to take a little bit of a pause. It still will be at a very elevated level compared to where it was below COVID, and it will start growing off of that elevated level. But I think it will take a pause because I think a lot of people will just want to get out and get somewhat back to normal. But we've, in effect, had a reset in the demographics that really is involved with e-commerce because a whole generation of people that before did everything analog are now used to doing things digital with this exception of wanting to get out in the short term and do some of the things that they missed doing. You know, if we could go back and figure out where e-commerce was before COVID and where it's likely to grow off of post-COVID, I would guess there's an 8% or 9%, maybe 10% change between those two levels, pre- and post-COVID. So we've got more than five, maybe seven years of e-commerce penetration that will be sustainable as a result of COVID.
spk09: Our next question comes from Caitlin Burrows from Goldman Sachs. Please go ahead.
spk07: Hi, good morning there. Just maybe on the customer retention pricing side, customer retention was 73% in the third quarter, which is the lowest since I think the end of 2018. So could you just talk about some of the drivers of that? Was it tenants impacted by general economic uncertainty, customers moving for more space, a result of your own stance on pushing price, or what some of the factors of that retention metric were in the third quarter? Yes.
spk18: Let me take a stab at that, because that's a really interesting question. I think you've heard many, many times from different people that this economic recovery is sort of K-shaped. There's the world of haves and the world of have-nots, and relatively little in the middle compared to most other periods. Well, both of those things on the two extremes will drive the tension down. The companies that are doing really well and expanding their business need more space. By definition, they can't stay in the same space and need to procure new space. And the companies that are at the bottom of the cave are going out of business or doing poorly, so they're going to give back their space. So I think as long as we are diverging from the middle for some period of time, you'll see declining retention together with the fact that we're pushing rents more than we were in Q2, certainly Q2 now, and that's likely to drive retention downwards. But having said all that, as large as our portfolio is of the billion square feet, once you go through how much of it quarterly turns, which is about 40 million feet, one or two leases can move that percentage around between 70 and 80 pretty significantly. So I don't get that excited quarter to quarter. I look at, you know, trailing four quarters as an indicator. And if you look at that, our numbers have been forever sort of anchored around 75%, a little higher, a little lower, but around that average.
spk09: Our next question comes from Eric Frankel from Green Street. Please go ahead.
spk19: Thank you.
spk18: Just first, can you comment on China's portfolio? Obviously, it's a small part of your portfolio, but it's obviously quite the opposite. It's quite different from the rest of your portfolio. And then second, I certainly agree that the property values are higher than they were in the pre-COVID days. But maybe can you comment on the difference in valuation between your larger global market to the regional market and whether you think there's a big valuation difference at this point. Thank you. Okay. Let me take a stab at both questions, and Gene may have more comments shortly on the second one. China occupancy is concentrated in Western China, in Chengdu and Chongqing. And as you know, it shows the operating metrics in a big way, but in terms of our share, it's actually a pretty de minimis kind of number. Having said that, the way land allocations work in China is that a city opens up, they allocate a bunch of land, and they put a requirement on you that you have to start construction in two years. And that obviously does not allow development to be matched with demand too easily because you have this sort of forced development starts that they impose on you for giving you that scarce land. So that happened on a number of projects in Western China that we kind of were forced to start all at once. And that went right into when China shut down. And as you know, Western China is very auto-centric. So the combination of all those things got a bunch of agency and in western china it it's about 70 percent of actually our total uh spec vacancy in the whole company uh but again the impact on our pno is going to be relatively uh small given our interest but we need to get at least and we are going through a strategy of uh actually um going for occupancy and being less rent sensitive because leases in china are very short in duration, and we're going to get that back. And we've seen exactly the same movie in years past in other regions in China. So we're pretty confident that it will not be an issue long term. With respect to valuation differences, I can't think of a place in the world where valuation has not increased post-COVID. Now maybe there are individual market by market differences but in terms of US, Canada, Mexico, Brazil, China, Japan, Europe, Europe is probably the number one declining Catholics among all the global locations and I think it has a direct correlation to two things. Interest rates are at historic lows, and everybody's pretty much concluded that they're going to be lower for longer. And secondly, the money that was otherwise being allocated to other sectors of real estate, like retail and hospitality and office, is actually not going there. So everybody's become a logistics a lot of that money. We're seeing people show up. That we never saw before. So there are a lot more players looking to buy space. And I think that's a pretty good thing if you own a billion square feet of this stuff.
spk09: Our next question comes from Michael Carroll from RBC Capital Markets. Please go ahead.
spk06: Yeah, thanks. Can you provide some color on the tenants and their sectors that are currently being negatively impacted by the pandemic? Has Prologis already worked through a bulk of these issues, or should we continue to expect a higher turn, lower retention over the next, I don't know, how many quarters, few to several quarters?
spk18: I think our retention is going to be between 70% and 80%, like it has been forever, and there's always change in the portfolio, and You know, the normal cast of characters is probably concentrated in retailers and big box retailers that are being disintermediated by e-commerce. But there are some retailers that are doing extremely well. Obviously, the home improvement sector, as Mike mentioned, and the grocers and the like are doing pretty well. And A lot of the ones that are doing sort of well but not super well are actually taking this opportunity to redo their networks and committing to new space because they now realize that e-commerce is not a theoretical threat to them, but they better get going on this because what they expected to see happen over five or ten years has happened in the last six months. So I think I'm not trying to duck your question, but, you know, you look at the list of, you know, the troubled retailers, the pennies and the shears of the world and all that and put it against our portfolio. We have one or two of them, but frankly, they're below my radar screen. I mean, they're so de minimis that, you know, our teams are very focused on them, on releasing them. And frankly, in many, many cases, those boxes are at least substantially below market. So we're happy to get them back and release them. It's not an issue we lose people to.
spk09: Our next question comes from Brent Diltz from UBS. Please go ahead.
spk05: Hi, thanks. You talked a lot about accelerating e-commerce and inventory builds, but could you speak in a bit more detail as to how those trends are developing in each of the global regions where you operate?
spk18: I'm not sure what you mean by detail. I think we were pretty early and adamant about this inventory rebuild. We went out and quantified it. at 5 to 10% and we gave you a projection on what that would mean in terms of incremental demand and the evidence that's come in since that time is pointing more to the high end of that range as opposed to the low end of that range. That is a general trend so it's expected more or less to affect all markets evenly because generally people are carrying more inventory. The cost of Carrying inventory is much lower because of interest rates, and the cost of missing on sales is very high. So people are generally carrying more inventory. With respect to e-commerce, I think we've been pretty specific about the percentages of sales that are going to go through the e-commerce channel and what the implications of that are on demand based on the 3X data. you know, factor. So, you know, I think you can take those two facts and apply it to historical demand pictures on every market and come up with a math, but I don't think it would be productive for me to try to go through 80 markets here and give you predictions that are not going to be correct anyway.
spk09: Our next question comes from John Peterson from Jefferies. Please go ahead.
spk06: Great, thanks. I'm hoping you guys can maybe talk a little bit about expectations around the election, maybe just high level if there's anything you're looking for that could impact your portfolio, but more specifically, California is a big market for you guys, and Prop 15 would increase property taxes on commercial properties. So curious how we should kind of be thinking about impacts of that if it does pass. And then there's also been talk about Biden getting rid of 1031 exchanges. And I'm just curious if you have any thoughts on what that would do to valuations and transaction volumes for the warehouse space.
spk17: Yeah, it's Gene. I'll take the Prop 15 and probably kick the other question to Tom. So with respect to Prop 15, first of all, we're going to see if it passes. The polling looks right now like it probably won't pass. But if it does, there are a few things to keep in mind. One, it's going to take a couple of years for the individual county assessors to respond, mobilize, and put it into action. The other thing is relative to Prologis, our average tax vintage is 2012. So we're in relatively better shape than, for example, local owners are. And, of course, this is passed through revenue to customers, and our real concern is taking care of our customers. And we hope this doesn't pass. It's just another tax in California to these businesses. But bottom line is long-term, not a big impact to us. Undeniably, there will be some. effect on the rent growth. But we've got to see if this passes first. And on 1031s, Tom, you should probably take that.
spk12: Yeah, I'll take that. Clearly, 1031s are very embedded in real estate transactions. That code, I think, has been around for almost 100 years. But I think there's two reasons why we can clearly manage. If that change does happen, I don't know the probability of that change. But if it does happen, we can manage it extremely well. The first thing is, from a sales perspective, we've always talked about we can be extremely patient. You know, we're very under-levered. We're, quite frankly, under-deployed a bit, getting back to probably Jamie's initial question. And so we can be very, very patient on sales. And then the second thing would be our dividend payout ratio is in the low 60s, close to 60% this year, and we're generating about $1.1 billion of excess cash flow. So what would happen if the 1031 exchange gets eliminated, right, our taxable income? could go up to the extent we sold assets, and the capital gain component of our dividend would increase. And, yeah, we put upward pressure on our dividend, but, again, we've got significantly low payout ratio, and we're generating $1.1 billion for cash flow. So while we utilize it, we can certainly manage around it.
spk18: I think the bigger issue than the two specific things you asked about is that California is becoming increasingly a difficult place to do business in. And it's not just these two things, but it's all the crazy propositions that are on the ballot this year. And if you really want to be entertained, you can read the ones that apply to San Francisco that are even funnier. But... But California better get its act together because otherwise they're going to kill the golden goose, and that is a concern for everybody. Having said that, it is the world's fifth largest economy and continues to be the center of innovation and a lot of other things around the world. So we muddled through, but sure, the politicians are making it very difficult for us for this economy to remain competitive. So that's much more concerning than POP 13 or 1031 specifically, at least to me.
spk09: Our next question comes from David Roger from Baird. Please go ahead.
spk00: Yeah, good morning. Tom, as we follow up on maybe those earlier comments Hamid made about the K-shaped recovery and that lower leg of the K that everyone's trying to figure out, is there a way you could give us straight-line rent write-offs that you've seen in the third quarter and year to date to kind of provide some color on that? And then maybe just a follow-up on the deferrals. I think you said 95% have been paid to date. Can you kind of give us a rundown just on the deferrals? I guess, level of direction of the deferrals. It seemed like maybe they were up a little bit in the third quarter versus second, but it may just be the way it's been quoted. So any color there would be helpful as well. Thank you.
spk12: Sure, Dave. Thanks. So on your first one, just regarding straight line rents, those are netted down against termination fees. So when you see our termination fees, those are net of those. I mean, listen, if termination fees are probably of average $3 million a quarter if you looked over a long period of time, I would bet, I don't have the precise number, but I would bet the straight line rent component is $1 million netted against that. So it's calculated. We've certainly taken into consideration in our bad debt calculation as well. Regarding deferrals, I've been very happy with the deferral collection. So we've billed deferrals to date are about $40 million of deferrals at 61 basis points of annual gross rent. We've billed $20 million of that, or half of it's due. We've collected 95% of that already. Most of that 5% to collect is really in October, but it's trending very normally with prior months, so I would expect the vast majority of all that to come in. Of the $40 million of deferrals, we'll bill a total of 80% of that this year, so we'll knock that out of the way. We've got about half of it collected already, and we'll get another 30% by the time we get to the end of the year. I think this should be wrapped up by the time we get to the end of the year. We'll have some that will roll into 21, but it will get taken care of in good order. I feel very good about collections and very good about referrals.
spk09: Our next question comes from Mike Mueller from JPMorgan. Please go ahead.
spk19: Hi. If you look at upcoming development starts into 2021, are there any significant size or geographical biases to the pipeline?
spk17: Hey, Mike.
spk18: Go ahead, Jim.
spk17: Sorry, Chris. Let me start. Chris, you probably have something to add, it sounds like. There really isn't, Mike, and in fact, I think that's unique about the situation that we're in. Other than spaces under 100,000 square feet, which we generally don't develop much in that sector anyway, demand has been and is becoming even more broad-based. So I really don't think there's any particular markets or product types I'd call out. Obviously, there's very significant strength in the big box sector, and we're going to meet that demand. But I don't think the composition of the deals looks much different than, for example, they did last year. Chris?
spk18: I would say in Europe, France and Poland are going to be low on that list in terms of places where I expect less than trend line development. And I think Japan is going to be busier given the strength of those markets.
spk09: Our next question comes from Tom Catherwood from BTIG. Please go ahead.
spk03: Thank you. Tom, going back to your opening comments, you talked about rent growth and occupancy lagging in spaces under 100,000 square feet. And then, Gene, you just mentioned that that has become a kind of broader-based demand center for certain tenants. But is the lagging occupancy and rent growth Do they have to deal with the K-shaped recovery because these tend to be smaller tenants in these smaller spaces? Or is it that companies are finding they could accomplish e-commerce fulfillment out of larger facilities that are close to but not directly in population centers?
spk18: It's a former. And frankly, the smaller spaces have two kinds of tenants in them. They have big tenants in smaller spaces for their customers. they're more closer in distribution and those are just doing fine and then there are smaller spaces, at least the smaller businesses that are more vulnerable to this economic downturn and therefore there's more churn there. I expect that to, and sort of the market getting better is because a lot of that churn took place in the early days and every day that goes by the survivors are surviving and holding on. I expect that to decline, the problems in the small spaces and the small tenants to decline and at some point it will flip because in the aftermath of economic downturns in the past business formations have really skyrocketed and I expect a lot of people that are either being laid off or by losing their businesses will get back, dust themselves off, and start new businesses. So that will come back, but it may be a lag. But big businesses and small spaces are doing just fine, not a problem.
spk09: Our next question comes from Craig Mailman from KeyBank Capital Markets. Please go ahead.
spk18: Hey, everyone. Maybe just going back to e-commerce and as it relates to maybe the U.S. specifically, but you guys throughout the what Amazon was and what 3PLs were. I'm just kind of curious, as you run the data and see what you think expected demand incrementally would be from kind of that pull forward of e-commerce demand versus what you've already kind of put in the books or what the pipeline looks like, do you have a sense of, you know, maybe describing as a wave, kind of when that wave kind of crests from a quarter perspective and we kind of hit the peak of that demand and it kind of trails off and how that is impacting potential development starts as you look out not just for you guys but for the market you know clearly you guys are turning spec back on I'm just kind of curious if others are turning spec on in anticipation of this and how that could potentially impact that rank growth as you know the expectation of the second half of 21 development deliveries would kind of really moderate if that may just not happen given kind of these other dynamics going on? I think we're in the early stages of certainly earlier than mid-stages of e-commerce growth. And I think what's happened in the last seven months is that we've got through five to seven years of growth. So I don't think we're going to get any of that back. I think we are going to plateau for a while as people go back to regular shopping and restaurants and not eating at home and all those things, and then it will pick right back up at a more elevated level. So the big wave you ought to keep your eye on is the tsunami of e-commerce coming through. What happens to the ripples on top of that big wave, frankly, and which quarter, I have no idea, honestly, and it varies market by market. But we don't run our business based on the ripples on top of the big waves. In terms of are there dynamics in the marketplace that could make it difficult for the demands of that wave to be fulfilled, the answer is yes. The most desirable markets are the ones with the tightest land, The most difficulty in finding large pieces of flat land that you can build these buildings that the e-commerce players demand, et cetera, et cetera. So with every passing day, we're having more demand from that sector. Now it's elevated and it's stabilizing at a much higher level, off of which it's going to continue to grow. And it's showing up a lot of the land that already was in short supply in the more desirable markets. I think that's the positive thing.
spk09: Our next question comes from . Please go ahead. Good morning. It's Michael here with Manny.
spk18: Hamid, I want to come to sort of your view on the asset management business. Tom had made a comment in the opening remarks about your business, Long Life, Perpetual, and comparing it relative to the listed asset managers in terms of how they're being valued versus how the business within Prologis is being valued. I think you have shown tremendous amount of creativity in terms of structuring your enterprise, leveraging a lot of different structures, whether they're externally managed listed entities, using funds, incentivizing management with part of the compensation structure in that business. I guess, are you thinking about taking it one step further and somehow making this entity either a public or a private entity to highlight that value, or do you view this just as within Prologis, and we just hope the market would give you the appropriate value? Excellent question. And let me just pile on your question. say there are two businesses, one is the development business and one is the investment management business, that I guarantee you, if I took the numbers of our development business, and it wasn't part of PLD, it was just a freestanding business, and by the way, we have those numbers going back to the year 2000, okay, and showed it to your home building analyst at Citi, I bet you he will value us a two and a half times book. devoted to development business, and a multiple that's more in the teens. And if I did the same thing with the investment management business, actually show them the numbers, the trends in those numbers, the permanent capital nature of most of those funds, well over 90% and the stickiness of those, and the promote history of those funds, I'm willing to bet you that they would put a 25 multiple on the pre-promote number and will give us the present value of the promotes on top of that. The net of it is I think both of those businesses are valued at about 30 to 40% of what they should be. Now, that used to really get under my skin and we spend a lot of time, you know, trying to figure out whether we can do a saucer section separation and all that kind of stuff. The governance issues that come along with that are very difficult and complicated and painful of where do you develop, how do you transfer it down? And frankly, it doesn't matter anymore. It's a $140 billion enterprise, and whether it's a couple billion dollars here and there in terms of incremental value, eventually people will get it and will give us credit for it. So I guess to answer your question in a very straightforward way, it's the latter statement that you make. We've kind of given up. The complexities are not worth it. you know, the incremental value that we may get in the short term. I'm sure we'll get it in the long term because the evidence is becoming so indisputable that it's kind of actually amusing at this point, more than annoying.
spk09: Our next question comes from Jamie Saltman from Bank of America. Please go ahead.
spk10: Great, thank you. You had talked about, you know, upping your outlook for net absorption to 210 million square feet and completion to 290 million square feet. Can you just talk more about what you're seeing from maybe non-REIT competitors in terms of their appetite to ramp up speculative development? And then also, you know, we had this delay in construction, but what does this all look like heading into 21? And do you have an early read on what your supply demand forecast looked like there? Yeah.
spk18: The answer to the second question is yes, we have an idea what it will be, but we will share it with you at the next call when we provide guidance for 2021. With respect to non-REAP players, you know, they continue to be by far the biggest in aggregate sector of development, have always been, will continue to be. The REAPs, as large as they may be, are big. I don't know, 20% of the business may be in the more relevant markets. So really the private market is the vast majority of these activities. And I would say, yeah, there is some undisciplined development in the private area, but I would say other than Poland, I can't really think of a crazy example of that. Maybe Houston, Poland and Houston. But by a factor of five, it's Poland and maybe somewhere in Houston. And the reason for it is not that these private developers or public developers have forgotten how to build buildings or are any less interested in building buildings. It's just really tough to find the land, the entitlements to build the buildings of the size that the market demands to meet a lot of this burgeoning demand from the big e-commerce users. So I think it's just tough. And... So development levels are going to be muted because of the difficulties of navigating that. I mean, in five-on-five periods, for large pieces of land in the desirable markets, meaning the Northeast, the West Coast, and all that, are literally three to four years on large pieces of land, and you've got to jump through all kinds of hoops and complexities. So it becomes difficult to tie up a piece of land to take it through the entitlement process. So you've got to buy a lot here, buy a lot there, and it's just difficult. So that's what I would say about it.
spk09: Our next question comes from Caitlin Burrows from Goldman Sachs. Please go ahead.
spk07: Hamid, I think before you mentioned that there's a lot more people showing up as it relates to the transaction market and acquisitions, but for Prologis' 2020 guidance, it was increased, I think now it's $750 million at midpoint from $600 million originally and lower than that last quarter. So could you just talk about the current transaction market and how those two pieces line up? It seems Prologis is more confident on your ability, but then the commentary that there are a lot more players.
spk18: No, there are a lot more players, and our acquisitions are not sort of the no-brainer acquisitions that are raised to who accepts the lowest IRR. Just to say that they're in the industrial business. We're not in that business. I mean, you know, we show up at every one of those auctions because we want to keep people honest and we want to know what's going on. But honest to goodness, we're not buying a whole lot of clean, perfect, you know, brochure cover qualities. I mean, if I told you about the market on some of those things, that we've seen recently, it's just beyond ridiculous. I think most of our volume comes from more infill, more repositioning plays, last touch plays, urban plays, sort of stuff that the ratio of the cost of money to The level of effort and talent is skewed towards level of effort and talent and customer relationships. So we go where our strengths are. If it's a race to who accepts the lowest IRR, that's not the business we're in. We leave it to people who really like that business. And there seem to be more and more of them every day. You know, but we have great visibility. As you know, you may remember that, you know, people always ask me about acquisition guidance, and I say, zero to 10 billion and we've exceeded it on the top end in the past and we've been zeroed other times. We don't have a budget for acquisitions because it all depends on pricing and availability of quality properties. You can make your acquisition patents if you want it to every year, but it would not be a prudent thing to do. But when you get this close to the end of the year, you have visibility on really what's happening not only this year but through the middle to third quarter next year, and that's what business accountants do to increase those numbers. But they're mostly high-effort value-added types of things, not that passive, no-brainer deals. Caitlin, I think that was the last comment. So I want to thank everyone for attending our call, and we look forward to being with you in the new year and sharing our 2021 guidance. Thank you.
spk09: Ladies and gentlemen, this does indeed conclude today's conference call. Thank you again for participating. You may now disconnect.
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