Prologis Inc

NYSE:PLD

Earnings Call Transcript 2020-Q2

[Operator]

Welcome to the Prologis Q2 Earnings Conference Call. My name is Jason, and I'll 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. [Operator instructions] Also note, this conference is being recorded.

I'd now like to turn the call over to Tracy Ward. Tracy, you may begin.

[Tracy Ward, IR]

Thanks, Jason, and good morning, everyone. Welcome to our second 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 in which Prologis operates as well as management's beliefs and assumptions. Forward-looking statements are not guarantees of performance and actual operating results may be affected by a variety of factors. For a list of those factors, please refer to the forward-looking statement notice in our 10-K or SEC filings.

Additionally, our second 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 Curless, Ed Nekritz, Gene Reilly and Colleen McKeown are also with us today.

With that, I'll turn the call over to Tom. And Tom, will you please begin?

[Thomas Olinger, CFO]

Thanks, Tracy. And thanks, everyone, for joining us today. We hope you and yours are all well.

The second quarter played out better than our expectations in terms of both our results for the period and outlook for 2020 and beyond. Leasing activity in our portfolio, market fundamentals, valuations and rent collections are all trending favorably.

Starting with results, core FFO for the second quarter was $1.11 a share, which included $0.23 of net promote income. Core FFO, excluding promotes, came in above our forecast due to higher NOI and higher strategic capital revenues. The increase in NOI was driven by lower bad debt and higher occupancy. For comparison, the quarterly results were in line with our initial 2020 guidance that we provided back in January.

Overall, rent collection trends are excellent. And as of yesterday, we've collected 98% and 92.1% of June [Technical Difficulty]. We've seen the pace of rent receipts accelerate each month since March, with collections ahead of 2019 levels for each month as well. As a result, our bad debt provision for the second quarter was 58 basis points of rental revenues versus our forecast of 160 basis points. Our share of cash same-store NOI growth was 2.9%, which included a 42 basis point negative impact from bad debt.

Turning to leasing and customer activity, segments benefiting [Technical Difficulty] economy remain very strong and continue to represent about 60% of our customer base. Leasing in the quarter by industry was well diversified, including from non-essential industries. E-commerce normalized to 24% of new leases. You'll recall from the first quarter, that number was 40% in the early days of COVID.

Negatively impacted segments include restaurants, hospitality, oil and gas and conventions. These segments represent just 1.7% of our annual rent. Over the last 30 days in our operating portfolio, we've signed leases amounting to [60.3] [ph] million square feet, up 24% year-over-year. Lease proposals have risen 21% year-over-year and lease gestation has declined by 14 days to 44 days.

Market fundamentals were stronger than we expected in the quarter and we are now forecasting the following for the US in 2020. Completion to total 250 million square feet, a 4% year-over-year decline, net absorption to total 160 million square feet, a 60% increase from our April view but down 40% year-over-year and year-end vacancy of 5%.

Our forecast for year-end vacancy rates in Europe and Japan have also improved now at 4.5% and 2%, respectively. Strong leasing activity in the quarter has moved the following markets off of our watchlist; Central PA, Phoenix bulk, Atlanta bulk and Guadalajara. Our watchlist includes Houston, West China, Spain and Poland, which moved back into the list this quarter due to extremely undisciplined spec development by one private developer in that country.

For strategic capital, the promote for USLF came in above our guidance, as Q2 valuations were higher than our forecast. Investor demand for our private funds remains very strong. Year-to-date, we've raised more than $2.2 billion of equity, approximately 17% ahead of our pace in 2019, which was a record year. Our open-ended funds currently have equity cues totaling $1.8 billion, with an incremental $1.4 billion in due diligence.

In Q2, a $448 million secondary trade in our health fund was made with nine investors at a slight premium to NAV, and $421 million will be redeemed in our USLF fund in July. Post these transactions, redemption cues for our open-ended funds will total just $10 million.

Looking to the balance sheet, we continue to maintain exceptional financial strength with liquidity of $4.6 billion in combined leverage capacity between Prologis and our open-ended vehicles at levels in line with current ratings, totaling over $13 billion.

Turning to guidance for 2020. Our outlook has improved from last quarter, given what we see in our proprietary data, our customer dialogue and the pace of rent collections. While there may be some headwinds in the back half of the year related to the timing and nature of economies reopening, we believe that our revised guidance range has taken those factors into account.

Here are the key components of our guidance on an our share basis. We are raising the midpoint by 50 basis points and narrowing the range of our cash same-store guidance to between 2.5% and 3.5%. This assumes a reduction of bad debt by 50 basis points with a range between 60 basis points and 90 basis points of gross revenues. This means at the midpoint we're forecasting to reserve about 110 basis points of bad debt in the second half of the year.

To date, we've granted rent deferrals of 48 basis points of annual rental revenues and continue to expect that grants for the full year will be less than 90 basis points. We are increasing our expected average occupancy midpoint by 25 basis points and narrowing the range to between 95% and 95.5%.

Occupancy was slipped slightly in the second half, so not as much as we guided to in April and end the year at a very healthy level. Globally, net effective rents declined by 1.4% in the quarter as a result of higher concessions, essentially giving back the growth from the first quarter.

Looking forward, we expect rents to be roughly flat for the back half of the year. Our in-place-to-market rent spread now stands at 13% and represents future growth potential of over $450 million of annual NOI. We expect rent change on rollovers to be more than 20% in the second half of the year.

For strategic capital, we expect revenue, excluding promotes, to increase by $15 million relative to our prior guidance, and now range between $360 million and $370 million. We're increasing our net promote income for the full year to $0.20 per share and we do not expect to earn any material promote revenue in the back half of the year. As a reminder, there will be a timing mismatch in the second half of the year, as we will recognize promote expenses of about $0.03 per share.

We are forecasting a G&A range of $265 million to $275 million, down $5 million from our prior forecast. Our outlook for capital deployment has improved significantly since April, and we now expect to start $100 million of new spec in the second half. Our revised starts range is $800 million to $1.2 billion for the full year, with build-to-suits comprising 65% of this volume.

In addition to this range, we plan to resume construction on $150 million of projects that were previously suspended. We are currently negotiating leases on roughly 40% of the TEI of these suspended projects. At the midpoint, we're increasing acquisitions by $100 million, contributions by $150 million and dispositions by $400 million.

We are now projecting net uses of capital to be $100 million at the midpoint. Taking these assumptions into account, we're increasing our 2020 core FFO midpoint by $0.125 and narrowing the range to $3.70 per share to $3.75 per share, including $0.20 of net promote income. This compares to our original guidance midpoint at the beginning of the year of $3.71 a share.

Year-over-year growth at the midpoint, excluding promotes of sector-leading at over 12.5%, while keeping leverage flat. Our three-year CAGR has been 10.5%, outperforming the other logistics REITs by more than 500 basis points annually. We continue to maintain significant dividend coverage of 1.6 times, and our 2020 guidance implies a payout ratio in the mid-60% range and free cash flow after dividends of $1 billion.

Looking forward, the long-term growth outlook of our business has strengthened. Our investments in data and technology provide us with the tools to identify pockets of risk and opportunity within our markets and portfolio, a significant competitive advantage.

I want to repeat some comments at the beginning because I'm not sure my sound was coming through. So, I just want to repeat our results for the quarter. Core FFO for the second quarter was a $0.11 a share, which included $0.23 of promote income. Core FFO, excluding promotes, came in above our forecast due to higher NOI and higher strategic capital revenues. The increase in NOI was driven by lower bad debt and higher occupancy. For comparison, the quarter results were in line with our initial 2020 guidance that we provided back in January.

Overall, rent collection trends are excellent and as of yesterday, we have collected 98% and 92.1% of our June and July rents, respectively. We have seen the pace of rent receipts accelerate each month since March, with collections ahead of 2019 levels for each month as well. As a result, our bad debt provision for the second quarter was 58 basis points of rental revenues versus our forecast of 150 -- 160 basis points. Our share of cash same-store NOI growth was 2.9%, which included a 42 basis point negative impact from bad debt.

Turning to leasing and customer activity segments benefiting from COVID economy remain very strong and continue to represent about 60% of our customer base. Leasing in the quarter by industry was well diversified, including from non-essential industries. E-commerce normalized at 24% of new leases. You'll recall from the first quarter, that number was 40% in the early days of COVID.

So with that, I'll turn it over to Jason for your questions

[Operator]

[Operator instructions] Your first question comes from the line of Steve Sakwa from Evercore ISI. Your line is open.

[Steve Sakwa, Evercore ISI]

Thanks. Good morning, Tom. Thanks for repeating some of that. I just wanted to circle back on just kind of the leasing activity. I know in the supplemental, you guys provide leases commenced and not leases actually signed in the quarter. Is there any -- and you did provide a little bit about the leasing activity in the last 30 days. But could you maybe just help us the actual leasing activity in perspective in Q2?

How much of that was impacted and how does that maybe change month to month to get to that [16] [ph] million square foot number for the last 30 days? And then could you just also comment on the drop in occupancy in Asia? Thanks.

[Thomas Olinger, CFO]

Okay. I'll start with that. So from a leasing perspective, we certainly saw leasing activity picked up materially in June. June was a very high month. And as I mentioned in the last 30 days, we've certainly seen our leasing accelerate. As it relates to occupancy in Asia, it's related primarily to China and small spaces under 100,000 square feet.

[Operator]

Your next question is -- my apologies. Go ahead.

[Thomas Olinger, CFO]

Next question, please.

[Operator]

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

[Craig Mailman, KeyBanc Capital Markets]

Hey guys. Just a quick question on kind of what activity you're seeing big box or small box. I know there were some concern earlier post COVID. Just curious, I know you guys took Phoenix and Atlanta big bulk off. I mean, are you guys seeing better activity across the board or is it still kind of primarily in some of the bigger spaces?

[Eugene Reilly, Chief Investment Officer]

Yeah, this is Gene. I'll take that one. We are certainly seeing better activity with bigger spaces and that is where the -- has led to taking those markets off the list. And conversely, small spaces have struggled. We see more softness in this category. And this is -- these are segments that we're focused on. But having said that, our property quality is excellent in those segments and we'll expect recovery. But right now, you certainly see better activity in the bulk spaces.

[Thomas Olinger, CFO]

Okay. Next question, please.

[Operator]

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

[Ki Bin Kim, SunTrust]

So a couple of questions. The higher leasing proposals that you've seen over the past 30 days, I think you said 21% higher. I'm just trying to get a sense of, is that mostly renewal activity for expansionary space?

And second question, when you mentioned all the positive leasing stats and you obviously increased your guidance for same-store NOI and build-to-suit activity. But if there are one or two things that you really looked at to give you confidence midway through the year to increase guidance, how much of it was based on customer feedback and the confidence your corporate customers are seeing versus hard metrics like leasing stats?

[Thomas Olinger, CFO]

Yes. Let me -- let me start by answering that question. Obviously, we're having some difficulties here with our conference operator. Yeah, the activity accelerated obviously in the month of June and it's pretty broad based. And I think, for the best indication of that, you can look at our build-to-suit volume because it's up substantially in terms of percentage and absolute amount.

And that tells you something about the scarcity of space out there because that's what people will have to turn to get their spacing needs met. So Mike, do you want to -- you want to elaborate on that somewhat?

[Mike Curless, Chief Customer Officer]

Yeah. We're seeing broad-based activity, everybody. If you believed all the hype you saw there, you would think it's all Amazon. But Amazon clearly is ramping up their activity, but we're seeing definite broad-based activity across a lot of sectors. Home improvements picked up.

Appliance business is strong and actually seen quite a bit of activity from the food crowd on our build-to-suit list. Then you got to remember is there's been plenty of structural rollouts that were announced and well underway pre-COVID. And so it's not just Amazon. They are a big part of it, but look, for a lot of broad-based demand and keep that build-to-suit list strong.

[Operator]

Your next question comes from the line of Nick Yulico from Scotiabank. Your line is open.

[Sumit Sharma, Scotiabank]

Hi. This is Sumit here for Nick. Just a quick question actually, following up on the build-to-suit. So there was, I think 100% of the pipeline this quarter was build-to-suit with a 48% margin. What's so special about these development spec that they are so accretive to the margin and there is such a wide spread between the development cap rate and the stabilized sort of market cap rate that would one -- one would anticipate?

And secondly, as a follow-up, just thinking about promotes. I know that fourth quarter has something coming up from Brazil, a core fund in Europe and the USLV. So, what's driving the lower expectations on promote income for those?

[Mike Curless, Chief Customer Officer]

Sumit, it's Mike. I'll hit the first one on the higher than normal build-to-suit margins. You're looking at a small sample that said, there are a couple of deals there that were more of the parking lot, leased parking lot flavor. And those tend to be very well located, have relatively low incremental investments, paired up with strong rents. Therefore, you see really strong margins, but I would look for those margins to blend in well over the year and normalized to the overall build-to-suit body of work in the mid 20s. Tom, you want to deal with the other one?

[Thomas Olinger, CFO]

Yeah. Sumit, on your second question on promotes in the second half, it's going to be lower, really small because the promotes are effectively just based on development. There is very little AUM in those funds. That is promote eligible in the second half. And remember, we've got $0.03 of promote expenses that will also will be incurring in the second half of the year.

[Operator]

Your next question comes from the line of Derek Johnston from Deutsche Bank. Your line is open.

[Derek Johnston, Deutsche Bank]

Hi, everybody. Thank you. Has COVID induced e-commerce acceleration pulled demand forward in your view? And secondly, where are we in the shifting secular landscape? Does it feel like we're mid to early late innings? Just would love your take. Thanks.

[Hamid Moghadam, Chairman and CEO]

Yeah, I think this is more like the Borg-McEnroe match back in the late '70s. We don't know how many innings are in this game. We keep going into overtime. And I think we're very early in the rollout of e-commerce. E-commerce started the year in the low teens in the US. The numbers vary in different places. And there is no telling how far it can go.

If it goes to 20% to 25%, which is where it was at the beginning early stages of COVID or stabilizes higher than that, this could be very, very early in the e-commerce rollout. And initially, obviously, we've had a clear market leader, which is Amazon in excess of 40% of the total volume, but we are seeing breadth in terms of different e-tailers that are now growing their businesses and have founded their footing. So, I think we're in very early stages and as you know, e-commerce has a sort of a supercharged effect on logistics' demand.

[Operator]

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

[Manny Korchman, Citigroup]

Hi, everyone. There's been, I guess, a rebounding concern in supply coming up. So two questions related to that. One, what are you seeing in terms of our conversion of use, whether that be retail properties or maybe even office properties and some anecdotal stuff that we've seen?

And secondly, are all developers being of this point of view and trying to keep their build-to-suit volumes high and their spec volumes lower? Are we running the risk that we're going to see a lot more spec not from Prologis, but from your competitors or peers?

[Eugene Reilly, Chief Investment Officer]

Yeah. Let me take the second part of that first. The places that we see undisciplined development are few. Poland is clearly one and I would say Houston is seeing more buildings than they should. I mean there's more product coming online in Houston than the demand warrants. But generally, I would not say there is an older building problem or anywhere near it. And if you look at the numbers that I think Tom talked about at 250 million square feet, that's about the normal run rate for construction.

And it's actually a little bit down from our forecast at the beginning of the year. So, I think this year demand will fall short of that level of construction, but it's not because the supply is excessive. It's because demand temporarily will take a dip. And in my view, we'll accelerate as we come out of this thing because of the growing percentage of e-commerce and also the need to carry more inventories.

With respect to the first part of your question, could you ask that again because I'm kind of a little unclear about it, oh, conversions, conversions. Look, there is a lot of talk about it and I think in time, you will see conversion, particularly of retail. And -- but there are obstacles and we should talk about those obstacles. Number one, a box in the middle of the shopping center is subject to all kinds of reciprocal easement agreements, and it's not really easy to go back and just redevelop one box.

Obviously, those boxes are in the right locations because they are in the middle of dense populations and high levels of income. So the locations are good, but there are internal dynamics that make it difficult to do that. So you have to respect the REAs and all the other arrangements. Also zoning is an issue because you need to convert from retail to industrial zoning and that takes longer than you can imagine because neighborhoods don't want trucks and traffic there.

And finally, there is an economic issue where these retail boxes are in somebody's books for several hundred dollars of square foot, and you need a number much lower than that to make sense for logistics because you need to also spend money to convert them to logistics uses. It's not like that they're set up that way. So, I think in time, you'll see more and more of this kind of development, but it's not a surge.

And I think we are involved in a number of them, but it's tougher and it takes longer than you can imagine. The stuff that you hear about hotel rooms or offices being temporarily used for logistics, we've seen that before during the holiday season when things get really crazy. But those are really for last touch distribution purposes. They're not really permanent space because economically, they're not viable for long-term logistics use.

[Operator]

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

[Vikram Malhotra, Morgan Stanley]

Thanks for taking the question. Just two questions. One, could you give a bit more color on kind of how market rent growth may have trended month over that -- over the last few months and particularly in the US versus global?

And then second, if you can give us a little bit more color on kind of utilization of the cost of capital that you now have, which -- there may have been questions few months ago, but today it's pretty robust. So I'm just wondering, can you give us a little bit more color between utilizing that for development acquisitions and maybe even M&A?

[Hamid Moghadam, Chairman and CEO]

Yeah. Thank you, Vikram. So two questions. With respect to market rents in the US, I think the best way to think about them is that we are basically on the same track were before, but with a pause and interruption. In other words, I would say in this era of COVID, the growth hasn't continued. I believe they will flatten for the balance of this year just like our guidance suggests. And then we'll pick up on the path of growth. And the reason I believe that is because there has never been a cycle growing into it or going into it.

We've had high occupancies, vacancy being under 5%, and also very high utilization rate in the mid 80s. And there is no sign that those numbers are in anyway deteriorating. So, I think the market continues to be strong and I think it will be back on a trajectory of rental growth, not too dissimilar with -- from what we were projecting at beginning of the year.

With respect to use of capital, I continue to believe that there is relatively little differentiation between different companies. So M&A is usually pretty tough. I mean, we've done it successfully in a couple of instances, but increasingly the targets are less and less compatible with our portfolio in terms of quality. And also, there is a pretty -- the companies are trading right on top of each other in terms of multiples. Don't ask me to explain that because the growth rates, at least, historically been substantially different. But I don't make the market react to it.

The place that is always the best use of capital for us is building out our land bank because we already have the land and the incremental returns on capital are the most attractive, particularly with the kind of margins that we were talking about earlier and Mike referred to now. That's a pretty disciplined business. You can't do an infinite amount of that kind of development, but that's the first place we would go to.

On straight acquisition of assets, look, I'd just like to -- I said last quarter, I don't think pricing of logistics real estate is going to soften. In fact, I think cap rates are going to compress because there is a lot of capital that's placed to go into real estate and obviously, there are sectors that are not going to attract their fair share capital like they did before. So that capital is piling in the few sectors that are performing well. So, I think the best use of capital is building out our land bank.

[Operator]

Your next question comes from the line of John Kim from BMO Capital Markets. Your line is open.

[John Kim, BMO Capital Markets]

Thank you. You talked about leasing volume being healthy, sounds like it's picking up. But you also discussed the dip in occupancy in the second half of the year. Is this an indication that you're looking to push rents over occupancy? Is it greater downtime from bad debt expense or this -- or are there other factors that contribute to this?

[Eugene Reilly, Chief Investment Officer]

Yeah, John. It's Gene. I'll take that one. I wouldn't -- I wouldn't draw a conclusion from the next two quarters forecast on our optimism about the demand. Demand has been good. As we mentioned at the outset and have, about 60% of our portfolio, customers are expanding, but some are shrinking. So it's a balanced view for the rest of the year. And the reality is that until we come out of COVID and we see economies reopening, we won't have complete clarity.

So, I would actually point to later in the year 2021, we're going to come out of this. And I think as Hamid said a few moments ago, I think you'll see a continuation of the rent growth. But until there is clarity on reopening, there has to be -- you have to have a balanced view.

[Hamid Moghadam, Chairman and CEO]

Yeah. And the only other thing I would add to that is at the beginning of the year, we're forecasting essentially 260 million feet of demand and supply, and now we're projecting 250 million feet of demand and -- sorry, supply, and 160 million square feet of demand, which is down from our original forecast. So if you forecast 90 million square feet of demand, obviously, you have to go along with a pause in rental growth. So that sort of outlook is consistent both between demand and the rental picture that goes along with it.

But when we come out of this thing, I think for reasons we've described before, namely an increase in inventory generally 5% to 10% and also the stabilizing share of e-commerce of the higher level than before will actually lead to a surge in demand, which will make up, in my view, more than the 90 million feet we lost or we project to lose this year. But nobody knows, I mean, these are all our best guesses.

[Operator]

Your next question comes from the line of Jon Petersen from Jefferies. Your line is open.

[Jon Petersen, Jefferies]

Great. Thank you. Good quarter, guys. I was -- first of all, hoping you could update us on how IPT and LPT are doing versus underwriting. But then also was curious with both those transactions, it greatly increased your exposure to the US. How are you thinking right now considering international markets seem to be getting back on their feet quicker than the US on exposure to the US versus exposure to international markets?

[Hamid Moghadam, Chairman and CEO]

Yeah. International is a big spectrum. And on one side of it, you have places like Poland, which is suffering from overbuilding. You have Spain, which has weakened demand and then you have places on the other end of the spectrum that you would never get. Tokyo is under 1% vacancy.

Osaka where the vacancy was in the teens is now in the 5% range, and we're leasing up pretty much everything we are building ahead of schedule. So obviously, there is a wide variety overseas. But if you sort of throw all of the overseas markets together, I would say generally, they are a tad slower than the US, but not materially so.

And Gene may have more granular comments on that, but very consistent actually in terms of -- in terms of market strength.

[Eugene Reilly, Chief Investment Officer]

Yeah. And you asked Jon about underwriting -- and we're actually a little bit ahead of underwriting on both of those portfolios, even through then what we've seen in the last few months. And we'll revisit that at the end of the year. But things are looking good. Obviously, for Liberty, the Houston exposure is going to be challenging for a bit. But on the other hand, Pennsylvania portfolio, which is the biggest piece of it, has actually done quite well, leading us, by the way, to bring Central Pennsylvania [indiscernible] a lot to us, so a little bit ahead of plan so far.

[Operator]

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

[Jamie Feldman, Bank of America]

Great. Thank you. I was hoping to get your thoughts on two points. Number one is, I know you mentioned what the -- this year's development pipeline looks like or deliveries look like. Can you give some color on what things look like heading into '21, given that there was this pullback in starts? And then also just given that you did increase guidance, just thinking about the lingering risks ahead, whether it's the election, PPP subsidies burning off, cases rising in other markets. Like what gave you comfort to get more positive here even though there are some things lingering out there?

[Hamid Moghadam, Chairman and CEO]

Customer behavior in short. Jamie, Gene is going to give you the real answer, but the short answer is customer behavior. We don't make the market. We just observe what happens on a real-time basis. But, Gene, go ahead and talk about the details.

[Eugene Reilly, Chief Investment Officer]

Yeah. I mean, specifically, Jamie, we're adding sort of a net of $250 million of spec to the plan. We're still way below the January forecast, and those are like 15 projects in 15 different markets. So, there are bets that are being placed based on the customer demand in those markets. And I wouldn't be surprised if that number increases. You also asked about what happens going into 2021. I think we'll wait to see what happens before we talk about 2021, but we obviously have a much more confident view on building spec today than we did in April.

[Operator]

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

[Dave Rodgers, Baird]

Yeah. Good morning out there. And just -- was thinking about your portfolio as you've moved more infill with respect to maybe service-oriented customers versus distribution-oriented customers. Wanted to kind of think about how those conversations are going with those customers and are you guys still targeting rents from the end of the year and they're accepting that? Is there a big differential between what they're anticipating in rents and what you are? So that's the first question.

The second is just for cap rate compression, do we need to get past the point of increasing vacancies? Do we need to see rents grow again before we see that materially happen? Or is the debt side of the equation enough to make that happen? Thank you.

[Hamid Moghadam, Chairman and CEO]

Dave, let me just start, and Gene will give you more details. On cap rate compression, we are already seeing it, particularly in Europe. And there is plenty of transaction evidence that those cap rates are holding and in some cases declining. And by the way that's in sync generally with our valuations that have been held flat and remember valuations are backwards looking. I mean if they were -- if they had the evidence of the last month of transactions, I think those values would be up.

With respect to distribution of space, as we've said many times, Prologis operates in all four categories of space, whether it's last touch, all the way to gateway cities, the larger spaces in major markets. And that distribution is pretty balanced. And in fact, we have a paper out there that's not too out of date, that shows exactly what our portion is in each category.

So, we haven't really materially changed our allocation to different markets. It's just that we get more questions about the last such markets these days than we did before. The old -- and this strategy was very much large markets than infill locations. So, that's where that portion of the portfolio in general is coming from, which is getting a lot of attention these days. Gene, do you want to elaborate on that?

[Eugene Reilly, Chief Investment Officer]

Yeah. The only thing I'd add is, you asked specifically about rent growth in infill locations. And to date, we have certainly seen much more, much higher rent growth in these locations. And as you can imagine, there is a bit of market pricing discovery going on because these are submarkets that generally are immature for this kind of use and the product types basically span a huge range. But so far those -- the growth in rents has actually surprised us to the upside.

[Hamid Moghadam, Chairman and CEO]

One other thought that I will just join there, you've heard us talk about this many times, but logistics rents are only 2% to 5%, call it or give it a wide range of total logistic costs and the rest being made by labor and transportation. So really the ability to pay for the customer is not the issue because even if they paid 20% more rent on an item that's 4% of their total logistics costs, that's 80 basis points more in costs.

So that's not what drives it. What drives really rental growth is how anxious is your best next competitor in terms of dropping out rents. That's what determines this, not the customers' ability to pay rent. And generally speaking, when you're operating at around 5% vacancy, which is where we are, there aren't that many competing spaces around. So, we continue to do -- we continue to have pricing power generally in most markets. Obviously, the Houston's of the worlds are different.

[Operator]

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

[Blaine Heck, Wells Fargo]

Great. Thanks. Good morning out there. So just a couple of questions here on rent collections and same-store. I think you gave rent collection figures for June that might be excluding deferred rents. If that's the case, can you give us the June and second quarter collection numbers based on the cash that's come in relative to kind of your pre-COVID billing expectations?

And then secondly, you guys have reported strong rent collection results relative to a lot of REITs out there. But it just seems to me like the amount of uncollected cash rents, it's still a pretty tangible headwind then for you guys to still post 3% cash same-store in the face of that headwind is very impressive, frankly. So maybe you can reconcile how cash same-store can be 2.9% with even a few percentage points of uncollected cash rents. That would be really helpful.

[Thomas Olinger, CFO]

Okay, Blaine. So on the rent collection, as I'll restate, so in June, we collected 98%. In July, we collected 92.1%. We deferred about 195 basis points of rent in June and about 70 basis points of rent in July. So that rents not due. So it's not in those numbers of those collections numbers. Now our collections, as I stated, are doing extremely well. We're ahead of last year since March. Every month, we're ahead of schedule. Now, we believe we are going to collect all the cash with the exception of what we think we've covered in a bad debt reserve.

So, we've assessed. We've gone through -- we've assessed industries, we've assessed space sizes. We've looked at all the different metrics. We've looked at individual customers across our portfolio and we feel really good about that bad debt range of 60 basis points to 90 basis points. Now it's lower than we had projected in April, for sure, meaningfully lower, but it's because of the collections are so strong. And if -- I would anchor back also to the fact that our bad debt history on average is about 20 basis points.

If you go back 14 years, 15 years, we've averaged 20 basis points of bad debt. Now, our high was 56 basis points in the GFC, and that's kind of what we saw here in Q2. So, I think we've got the second half bad debt adequately covered in the range probably and then some. And I feel good about getting the rest of this cash in the door.

[Operator]

Your next question comes from the line of Michael Carroll from RBC. Your line is open.

[Michael Carroll, RBC]

Yeah. Thanks. Gene, I wanted to dig in a bit -- individual market trends that you highlighted. Can you provide some color on what drove the improvement in Central PA? Is it just better demand? And then also with the issues that you're seeing in Houston, is that simply just supply in a weak energy market? And are developers slowing down construction activities? So it's just going to take time to absorb that space or are these longer-term issues that we have to deal with?

[Eugene Reilly, Chief Investment Officer]

Yeah. So in Pennsylvania, it's all leasing. So the improvement is related to leasing. In Houston, you have obviously two headwinds in demand. You've got energy pricing as well as COVID. And you have a huge amount of construction in progress at the beginning of this year. Now, some of that was suspended. But frankly, the vast majority was not. So, you're going to have an overhang of space in Houston easily going into next year some time, because there's just so much supply.

In terms of developers being disciplined or not, I think, frankly, the jury is out on that. Right now, things appear to be disciplined. But I would have hoped frankly that we would have seen more projects stopped. We didn't see that. So I think we -- I think we need to monitor that aspect of it, but unfortunately in Houston, you have a supply issue as well as the demand issue.

[Operator]

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

[Eric Frankel, Green Street Advisors]

Thank you. Just to talk about e-commerce again. Obviously, Amazon has been quite active. And Mike, you commented on some of the longer, longstanding supply chain reconfiguration efforts by home improvement -- home improvement companies, appliance companies, food and beverage. Could you talk about how some of the big box retailers are adjusting to because they obviously had a huge surge in e-commerce sales. I'm just curious if they've adjusted there or they looking to adjust their warehouse footprints at all?

[Mike Curless, Chief Customer Officer]

Yes, Eric. Thank you. We are seeing activity from those retailers, not at the pace we're seeing from the traditional e-commerce, but we certainly have on our prospect list some household names that you would consider in the retail business that are looking to shift from brick and mortar and to more warehouse to consumer shipments. So, we're definitely seeing an uptick in that segment.

[Hamid Moghadam, Chairman and CEO]

Yeah. Home improvement and grocery sectors are particularly strong.

[Operator]

Your next question comes from the line of Tom Catherwood from BTIG. Your line is open.

[Tom Catherwood, BTIG]

Thank you and good morning. I just wanted to actually follow on Eric's question about retail and specifically from the bricks and mortar side. Since 2011, obviously, you've reduced your exposure to lower growth industries. But I assume no one is immune to the pain that's happening in brick and mortar retail. So first off, I know it's a small number, but can you remind us what your exposure is to brick and mortar retailers, especially on the apparel side?

And then second, is there a risk that challengers could show up for some of your other tenants like 3PLs that have retail exposure of their own, almost like shadow retail exposure for Prologis?

[Chris Caton, SVP, Head of Global Strategy & Analytics]

Hey. This is Chris. Thanks for the question. So first, as it relates to apparel specifically, that is roughly 7% of our customer base and there is going to be both native e-commerce and traditional brick and mortar retailers in there. So, you're going to have a diversity. Our approach, our analysis looks through the organization. So whether it's a retailer, whether it's a 3PL, so we think through that exposure just like you described in. So the way we've been talking about it for the whole decade has been consistent with how you're thinking about risk.

[Operator]

Your next question comes from the line of Mike Mueller from JPMorgan. Your line is open.

[Mike Mueller, JPMorgan]

Yeah. Hi. Are there any changes to the lease durations for the bumps that you've been getting in recent leasing activity?

[Hamid Moghadam, Chairman and CEO]

Not materially. Mike, not materially. Right before this thing, the lease durations had extended, probably the longest we've seen in about a decade. But -- and basically leases that are of term has stayed about the same level of duration. While we have higher month-to-month leases and that is pretty typical of what happens in this part of the cycle where normally somebody who's business was growing may be coming out of a smaller space going to the bigger space or going the other way frankly. But moving is expensive and committing to a new space is expensive.

So, sometimes the best solution is just to basically pay overage rent and kick it out couple of months. So, we have a higher percentage of leases under one year. But the ones that go longer than a year are about the same profile as they were before. And with respect to escalation structures, pretty much consistent with before, slightly more free rent on the front end, which is how the effective rent comes down. I think Tom mentioned that the effective rents were down 1.7%. Face rents haven't changed all that much in most markets.

[Operator]

Your next question comes from the line of Nick Yulico from Scotiabank. Your line is open.

[Sumit Sharma, Scotiabank]

Hi, guys. Sumit here again. Thank you for taking my question again. So Walmart is closed on Thanksgiving, and that goes to assume that they are expecting more online sales traffic. Layering in Prologis' US portfolio and thinking about it from a infill perspective, how does that manifest in terms of increased rent growth for those properties?

What I'm thinking of is not your properties off of Tracy or Exit 8 New York City, but more kind of stuff that you have in, let's say, the Meadowlands in New York City or Bronx. When you're underwriting these properties, what's the sort of rent growth you're putting in today? And how does situations on the grounds like what we are hearing with Walmart and other retailers change your view?

[Hamid Moghadam, Chairman and CEO]

The thing I would say about Walmart specifically is that, obviously, we had them in one property in the Bronx. And as you probably have read in the headlines, they no longer needed that property because of what you described and we were able to re-lease it with no interruption to another major e-commerce player at actually very attractive economics. So that's the only direct impact that I can see from Walmart if your question is specific to Walmart.

And they didn't have much of a presence in the New York area anyway too, for it to be a headwind. So, they were just really getting started. They had tried for many years to get into that market, but it had proven to be a difficult market to get into. And it appeared for a while that e-commerce was the way they were going to come into the market and apparently, they've changed their mind. I don't know if your question was broader than Walmart. But that's the story with Walmart.

[Operator]

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

[Michael Bilerman, Citigroup]

Hi. It's Michael Bilerman with Manny. Hamid, at the November Investor Day, one of the topics the team has spent a lot of time focused on was trying to have value beyond the real estate and really trying to find solutions to a lot of the supply chain costs that would essentially allow you to be able to garner more rent. So looking at transportation, digital data solutions, looking at labor costs and trying to find opportunities for your tenants to reduce those costs and ergo allow them to pay you more rent.

And I think you talked a little bit earlier before about how rent is a smaller part of the overall cost structure. Therefore, if we're able to get benefits from all those other items, we should be allowed to charge more rent. Where do you sort of stand? And have you been able to advance any of these initiatives further, ultimately getting to that, I think it was like a $150 million of potential upside over time as you implemented these things?

[Hamid Moghadam, Chairman and CEO]

Sure, Michael. I'm glad you brought that up because that's a very important part of what we are spending time on. And I'll let Gary give you the real answer. But from my vantage point, our performance there has been mixed. So with respect to the things that are going very well, I would say our LED initiative, our procurement initiatives, our services and our product offerings that go with the use of warehouse are going pretty well and are generally on track. The more aspirational aspects of our product offerings, transportation, IoT, I would say those are too early to have a result. On the labor front, we're actually making really good progress as well.

So it's a mixed picture. COVID has also obviously interrupted our ability to market some of those services to our customers. They are frankly focused on other problems right now. But we come up with new products to offer to them in this time, like deep-cleaning services and other things that we rolled out were specifically targeted towards COVID.

And so I would say, our enthusiasm for that business is the same or stronger than it was before and I would say materially stronger than before. Our execution of it has been pretty good in some areas and has been interrupted by COVID in some other areas, but we haven't changed our objectives in the medium term on that. Gary, do you want to provide more color there?

[Gary Anderson, COO]

Yeah, just a little bit. Michael, if you remember, we had shown a bull's eye at our Investor Day. And the kind of the bull's eye is the area that we were currently focused. Those are the areas that Hamid was talking about. In that period that we've gotten some pretty good traction. So -- and growing revenues there, it's not huge. [Technical Difficulty] delayed for transportation and IoT and we believe that those are little bit longer term. In [indiscernible], I think we're more optimistic about essentials, then we would leave it at that point.

[Operator]

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

[Ki Bin Kim, SunTrust]

So if I remember correctly, when you guys bought Liberty and IPT, it was part of the original plan to sell off assets. And you've done a lot of it already, but I believe 2021 was supposed to be a kind of material year for dispositions. Any update to those plans?

[Hamid Moghadam, Chairman and CEO]

Yeah, Ki Bin, if you remember in the last call and actually the call before that, we pushed that back. We are very under deployed right now. Our leverage is under 20%. And so there is no rush whatsoever to sell those properties. If you do a little bit of poking around, you pretty quickly figure out that we've got a pretty significant portfolio from IPT -- from Liberty for sale in the UK. And that one, we are in the process of collecting letters of interest and offers.

And I would tell you that demand for that product is triple or quadruple what we expected. And I think we're going to have a very strong execution on that. But on the rest of it, we're not -- we haven't even put out the packages because why do it? We don't need to do it right now and we can adjust a bit. That's very liquid real estate and we can do that anytime and our decision is to push that out until we have more deployment and meet the capital frankly more.

[Operator]

Your next question comes from the line of Jon Petersen from Jefferies. Your line is open.

[Jon Petersen, Jefferies]

Great. Just a quick one. I know we are top on the hour here. Any chance you guys could break out rent collection between Europe and the US? Asia is smaller, but maybe there too. I'm just curious if there is any material difference between those markets.

[Hamid Moghadam, Chairman and CEO]

Yeah. We actually look at that on a daily basis and, obviously, even more detail than what you just asked. We look at it by country, and we can have the ability to actually drill it down by market. So obviously, we're always focused on collections. But I would say we are a lot more focused on collections in the last four months or five months. And we have very good data on that.

I would say there are two countries that stand out as collections being materially lower than elsewhere. And those are France and the UK. And part of it is that the government has gone out there and basically said, you don't have to pay your rents. And so a lot of people are -- and a lot of very healthy companies, I mean, household names are just choosing not to pay the rent for now. But their ultimate collection of those numbers, of those rents are not subject to those regulations. And we believe we'll collect the vast majority of them.

But if you take those two markets out, Asia is on the other side, we have no deferrals or no late payments almost or no defaults to speak up in Asia. So if you throw it all in the blend there, the numbers are very comparable between the US. They are within a couple of 100 basis points between the US and the rest of the world. And with the two that I mentioned being the meaningful deviations.

I think that was the last question. So, really want to thank you for your participation. Sorry about all the logistical glitches today, but that's the world we live in. And we look forward to talking to you next quarter. Take care.

[Operator]

That concludes today's conference call. You may now disconnect.