Prologis Inc

NYSE:PLD

Earnings Call Transcript 2020-Q3

[Operator]

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. [Operator instructions] 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.

[Tracy Ward, IR]

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 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 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 Curless, Ed Nekritz, Gene Reilly and Colleen McKeown 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?

[Thomas Olinger, CFO]

Thanks, Tracy. Good morning, everyone and thank you for joining our call today.

Our third quarter results were strong and 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 market, our proprietary data reveals that operating conditions are meaningully better than they were 90 days ago and as a results our earnings are now ahead of pre-COVID levels. The Prologis 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 that our properties are returning to near key capacity.

On a size adjusted basis, signings were up 31% in the third quarter and up 4% year-to-date. Customers continue to make decisions faster than ever of lease gestation less than 50 days. Proposals remain at healthy level up 3% sequentially and up 12% on a year-to-date basis. This positive momentum have led us to raise our market forecast for 2020. In the US, 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 a very healthy finish to the year.

We've also upgraded our yearend 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 rent growing as a result. As we look to space size demand broaden across segments this quarter to include a 100,000 million square feet and above. Spaces 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 rent 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 Omni channel and pure online retailers are growing and while Amazon is very active particularly with build-a-suit, they represented just 13% of our new leasing.

Second, three 3PLs represented more than a third of new e-commerce leasing in the quarter, a record of customers raise 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 the quarter, the most active segment support essential industries including food and beverage, healthcare and consumer products.

Another new emerging structural drivers that lead for resilient supply chains and higher inventory levels, the inventory for sales is follow-on to the world [ph] on record and many customers are operating with a razor thin inventories. We see time for restocking process has begun.

[indiscernible] our results, we had a strong third-quarter with core FFO per share of $0.97. We outperformed our forecast due to higher NOI, strategic capital revenue and termination fees partially offset by slightly higher G&A. Rent change on rollovers continues to be strong at 25.9% and led by the US at 30.7%. Rent collections remain ahead of 2019 levels.

As of this morning we collected over 99% of third quarter rents and over 94% of October. In addition, we received 95% of deferred rents due to date. Net 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 NOI growth was 2.2% despite the impact of lower debt, occupancy and bad debt. This peaks to the underlying strength of our rent change, the primary driver of same store growth in 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 vehicle, totaling more than $13 billion. We also continue to refinance debt opportunistically setting records in the quarter for the lowest REIT and third lowest US investment grade 10 and third year coupons and history. For strategic capital, investor demand is unabated. Our team rights over $800 million of new equity this quarter and the cues 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 forward behind us our revised guidance range has taken that into account.

Here are the key components of significant guidance changes on an odd share basis. We're narrowing our cash same-store NOI range between 2.75% and 3.25%. At the midpoint this assume a 25 basis point reduction of bad debt with a new range between 45 basis points 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 point ahead of our prior forecast.

After prioritizing occupancy for most of the year, we resumed pushing rent 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 striving 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 NOI growth potential of approximately $450 million annually.

For strategic capital, we expect revenue excluding from a range between $380 million to $385 million. The revenue growth of our business has been excellent with a five-year revenue CAGR excluding promotes of over 16%. The vast majority of this revenue is derived from occurring asset management fees from our perpetual or life vehicles. When we look at multiples being ascribed to this business, our view is that they're far too low.

The comparison public asset managers are valued at a multiple of more than 20 X on par less 50 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 billion and $2 billion up $800 million from our prior forecast. Build a suites will 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 valuation and current market activity, pricing for our properties is now pushing well beyond pre-COVID levels. Taking these assumptions into account, we're narrowing our range and increasing our 2020 core FFO midpoint by $0.045 to $3.76 to $3.78 per share. This includes $0.21 of net promote income which is up a penny from our prior guidance. Year-to-date growth at 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, [indiscernible] were ahead of our pre-COVID earnings expectations.

In clothing our performance is a assessment to the foundation we've been building for more than a decade. Our three-year earnings phase 11% has outperformed the other logistics REITs by more than 500 basis points annually, despite a greater relative decline in leverage. The work that we've done indicates 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 question.

[Operator]

[Operator instructions] Our first question comes from Emanual Korchman from Citigroup.

[Manny Citigroup]

Tom, just in terms of collections, they're obviously strong and they continue to be strong but there is a downward trend. Is there any [indiscernible] in those numbers that we should be mindful of or anything that you think might drive a quick recovery there than we're looking for?

[Thomas Olinger, CFO]

Manny, collections have been excellent. Actually there's no downward trend. If anything, they're trending up. If you looked at our collections, we're up over 94% this morning and we had a call in Q2 July collections were at 92%. So we're 200 basis points 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 am very, very pleased with where collections are.

[Operator]

Our next question comes from Derek Johnston from Deutsche Bank. Please go ahead.

[Derek Johnston, Deutsche Bank]

So the 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've pushed rents harder without the pandemic or has the pandemic perhaps propelled rent growth? And then lastly, do current rent trends have lagged in your opinion? Thank you.

[Hamid Moghadam, Chairman and CEO]

Hi Derek, it's a good question and one that we ask ourselves often, but there is no going back and playing that hand again because 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 push rents harder have we known how this was going to play out, of course we didn't.

I think that its gas in the tank for the next 12 months. So I am pretty optimistic about our ability to continue to grow rents and 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 worked 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 fueled for our future growth.

[Operator]

Our next question comes from John Kim from BMO. Please go ahead.

[John Kim, BMO Capital Markets]

This quarter you had sequential occupancy declines of 200 basis points in both Chicago and Houston. I am assuming this is based on new supplies, but just wondering about the case and also other markets we're concerned from both supply sectors.

[Eugene Reilly, Chief Investment Officer]

It's Gene. I'll take that and others may pile on. Houston for sure is going to face headwinds. There's a ton of supply in that market and you guys know the story there. Chicago, we feel a little bit better about. Actually that market is fairly strong and elsewhere in the US from a supply perspective, things actually look pretty good. We have seen in this quarter a significant increase in absorption and a corresponding increase in supply in supply during a very low vacancy rates across the board. So we actually feel pretty good and in the US, Houston would be the concern on supply at this point.

[Operator]

Our next question comes from Jamie Feldman from Bank of America. Please go ahead.

[Jamie Feldman, Bank of America]

Thank you. Tom, you talked about $13 billion or so of liquidity. Can you help us understand just think through what if there is any opportunistic acquisitions out there where you might be able to put some of the capital to work over the midterm?

[Thomas Olinger, CFO]

I think we're – the key for us is for opportunity for expand our growth potential and when those things occur, target determined, 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 markets these days. The pricing for our product is well above where we were pre-COVID. So there's a lot of interest for product.

[Operator]

Our next question comes from Blaine Heck from Wells Fargo. Please go ahead.

[Blaine Heck, Wells Fargo]

Tom, you noted that you guys are assuming parts of a little bit more than $1 billion that your share in the fourth quarter. Can you guys still talk about how much of those are built-a-suite 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?

[Thomas Olinger, CFO]

I'll start with that question and I'll kick it over to Mike, but it's probably good to talk about spec development overall and with what our picture looks like. So it's more 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 10 of those projects and about half of 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've anticipated in January, but it's pretty close to those volumes. So we will be down slightly with respect to spec development during 2020 versus the January forecast. We're actually up significantly with respect to the build-a-suite value. So that's what coming. And Mike you provide some color on that.

[Mike Curless, Chief Customer Officer]

Yeah Blane, let me add to that. We saw a really strong Q3 in terms of build-a-suit particular in Europe with six project starts there across a diverse set of customers and our overall prospect list, you heard us say this last time, there 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 in a quite at the pace.

Of course Amazon is a big part of that, but it's certainly not all of it and there is quite a bit of activity in the structural changes that we announced by the home improvements, the food customers, pre-COVID that they're now acting on at a quicker pace than even anticipated. So we're confident in the diversity of our build-a-suite pipeline and the strength of it. So we're optimistic for the fourth quarter.

[Operator]

Our next question comes from mongooses from Nick Yulico from Scotiabank. Please go ahead.

[Unidentified Analyst]

This is Sumit [ph] 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 free standing retail component that guys you estimated 40 million square feet of conversions or 50 Bps to 150 Bps of your market share.

Why is it so little when these are located in more densely traffic routes as well as are more supportive are most supportive parcel sizes. Since you did, I think one of the developments in the Bronx is built over a 2 acre lot which is far less than the 5 acres to 6 acres that is typically required. So shouldn’t this support more conversions across other areas and obviously putting full conversions aside, what drives the convictions that tenants could actually lease up these boxes or other nonperforming shopping centers for smaller delivery operations? Any color, any insights in attendance would be great.

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

Hey Sumit its Chris Caton. Thanks for the question. First for those who aren’t familiar what you're talking about, moderately talking about Prologis Research published a paper on Prologis.com. We size the retail to logistics trend. We estimated it being 5 million 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 its existing logistics real estate facilities for a lot of reasons.

So Sumit focused on the freestanding retail, that is in fact the largest category and so that is where we expect to see the most conversion opportunities. Well, if the challenges are many and varied in terms of conversion trends, whether it's physical and the ability simply view the site whether it's economic and land versus development cost and higher and better use opportunity, whether it's local politics or whether it's just the legal situation at the site.

[Hamid Moghadam, Chairman and CEO]

Yeah, the other thing I would add to that is that in freestanding retail by large is more western and southern phenomenon because by definition those cities are less spends 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 has 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 not the places that there is heavy duty last touch that demand. The trick is getting the availability and the demand picture in the same spot.

[Operator]

Our next question comes from Vikram Malhotra from Morgan Stanley. Please go ahead.

[Vikram Malhotra, Morgan Stanley]

Thanks for taking the question. Just to build off the question on moving spread, you alluded to the fact that you sort of extended the trajectory into next year. I'm just wondering can you give us your updated thoughts on actual market rent growth and from the key areas in the US, but also maybe in some of the global markets, just wondering if all the factors you laid out as potentially accelerated that trend as well into '21 in terms of actual market growth. Thanks.

[Hamid Moghadam, Chairman and CEO]

Hi Vikram, thanks for the question. So as Tom shared in his remarks, global rent growth is on pace for 2% this year of Prologis share basis, higher than that in the US, roughly flat in Europe and the US and better than that call it 1% in Japan, that's a good number for Japan. What that looks like in 2021, we don't disclose the numbers, but what I do think about other headwinds and tailwinds for our business and to an earlier question, these trends suggest an improving trajectory for rent growth.

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 got to say that against the lack of clarity on COVID and some of the challenges that are intended with the recession that will play out in 2021.

[Thomas Olinger, CFO]

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 US, unless something really strange happens, I expect that number to be pointed up. Now how much up in the last 106 years we've always underestimated rental growth. So I don't know, but the primary driver of earnings growth is going mark-to-market anyway whether on the margin rents growth 3% or 4% or 5%, that incremental amount at least for the next year or two is going to be determined of earnings growth.

So I'm not duck to your question. I'm just given that the kind of small changes we're talking about here, I don't think the earnings implications are significant.

[Operator]

Our next question comes from Steve Sakwa from Evercore ISI. Please go ahead.

[Steve Sakwa, Evercore ISI]

Thanks, just a quick question 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 it's a late development need 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. How long and sustainable do you think the development pipeline can stay over $2 billion, given the -- it seems like the growing demand pipeline you got from not just e-commerce but other categories that Tom mentioned.

[Thomas Olinger, CFO]

I'll take the first question. So with capital and cash same-store, it's lot at the midpoint at it's all timing because we have significantly high rates 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 commencement 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 that same-store went up 25 basis points another bad debt. So it's really a timing issue from that initial drag on cash same-store.

[Hamid Moghadam, Chairman and CEO]

I think with respect to the legs of e-commerce and the effects 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 could take a little bit of a pause. It still would 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 pause, because I think a lot of people will just want to get out just somewhat back to normal, but in effect had a reset in the demographics that really have evolving e-commerce because the whole generation of people that before did everything analogs are now using digital. With the exception of wanting to get out in the short term and do some things that they miss filling, but if we could go back and figure out where e-commerce was before COVID and it's likely to grow off of post COVID I would guess there is an 8% or 9% maybe 10% change between those two levels pre and post COVID.

So we got one in five maybe seven years of e-commerce penetration that will be sustainable as a result of COVID.

[Operator]

Our next question comes from Caitlin Burrows from Goldman Sachs. Please go ahead.

[Caitlin Burrows, Goldman Sachs]

Just maybe on the customer retention pricing side, customer retention was 73% in the third quarter which is a low expense I think the end of 2018. So could you just about some of the drivers of that, whether tenants impacted by general economic uncertainty, customers moving from our stated results and some pushing price or what are some of the factors of that retention metric were in the third quarter?

[Thomas Olinger, CFO]

Let me take a stab at that Caitlin because that's are really interesting question. I think you’ve heard many, many times from different people that this economic recovery is still occasional. There is the world of haves and the world of have-not and relatively literally in the middle compared to most other periods. While both of those things drive [ph] attention now, the companies that are doing really well and expanding their business need more space by definition against same space and lead to secure new space and the companies that are at the bottom of the K are going out of business or doing poorly, so they're going back of their space.

So I think as long as you're divulging from the middle for some period in 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 margins in our portfolio if of the billion square feet, once you go through how much of its quarterly turns, which is about 40 million feet one of the few retails can move that percentage around between 70% and 80% pretty significantly.

So I don't get that excited quarter-to-quarter. I look at trailing fourth quarters as an indicator and if you look at that, our numbers have been forever, so anchored around 75% and little higher and little lower, but around that average.

[Operator]

Our next question comes from Eric Frankel from Green Street. Please go ahead.

[Eric Frankel, Green Street Advisors]

Thank you. Just first, can you comment on China's portfolio? Simply obviously it's more part of your portfolio, there is obviously quite the opposite, it's quite different from the rest of your portfolio? And then second, that values are higher than were in the pre-COVID days, can you comment on the routine valuation between your larger global markets and the regional markets or whether you think there's a big valuation different at this point. Thank you.

[Hamid Moghadam, Chairman and CEO]

Okay. Let me take a stab at both questions and Eugene may have more comments certainly on the second one. China occupancy is concentrated in Western China in Chengdu and [indiscernible] and then you know it shows the operating metrics in a big way but in terms of our share of that way pretty de minimis kind of number.

Having said that, the way land allocations work in China is that it opens up they allocated by Thailand and the requirement value that you have to start construction in two years and that obviously does not allow development to be matched with demand fees because you have this sort of worst development starts that they impose on you for giving you that scarce plan. So that happened on a number of projects in Western China that we will had of course to start all at once and that one right into when China shut down and Western China is very auto centric.

So the combination of all those things got a bunch of vacancy in Western China. It's about 70% of total spec vacancies in the whole company, but again the impact on our P&L has been relatively small given our interest, but we need to get a belief and we are going through a strategy of actually going for occupancy and be 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 individuals market-by-market differences, but in terms of US, Canada and Mexico, Brazil, China, Japan, Europe, Europe is probably the number one declining CapEx among the global locations and it has a direct relation to two things. One interest rates are at historic lows and everybody is 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 has become a logistics aficionado, so a lot of that money.

We're sort of seeing people show up that the number we saw before. So there are a lot more players on the device space and I think that's a pretty good thing if you own a billion square feet of this stuff.

[Operator]

Our next question comes from Michael Carroll from RBC Capital Markets. Please go ahead.

[Michael Carroll, RBC]

Can you provide some color on the tenants in those sectors that are currently being negatively impacted by the pandemic? Has Prologis already worked through both of these issues or should we continue to expect higher churn, lower retention over the next how many quarters, several quarters?

[Hamid Moghadam, Chairman and CEO]

I think our retention is going to be between 70% and 80% likely it has been forever and there's always churn in the portfolio and the normal characters are probably concentrated in retailers and big box retailers are being dis-intermediated by e-commerce, but there are some retailers that are doing extremely well. Obviously there are home improvement sectors as Mike mentioned and the groceries 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 community lease space because they now realize that e-commerce is not a theoretical threat to them, but they better next time 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 look at the list of the troubled retailers the Penny's and the [indiscernible] world and all that included the day portfolio, we have two of them that frankly been below my radar screen. They're still de minimis but our teams are very focused on moving and there are frankly many, cases those boxes are at least substantially below market. So we're happy to get them back and it's not an issue we usually look at.

[Operator]

Our next question comes from Brent Thill from UBS. Please go ahead.

[Brent Thill, UBS]

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?

[Hamid Moghadam, Chairman and CEO]

I'm not sure what you mean by detail. I think we were pretty early and adamant that its inventory rebuilt. We went out and quantified at 5% to 10% and we gave you a projection of what that would mean in terms of incremental demand and the evident that's come into that time is pointing more to the high end of that range that it puts to the line of that range, that is a general trend, so it's expected more of less to affect our all markets evenly.

The general people are carrying more inventory. The cost of carrying inventory is much lower because of the interest rates and the cost of making sales is very high. So people are generally carrying more inventory. With respect to e-commerce, I think they'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 factor.

So I think it can us through facts and apply to historical demand pictures in every market and cost of demand, but I don't think it's would be good for me to try to go through the markets we're in with the prediction that are not going to be correct anyway.

[Operator]

Our next question comes from Jon Petersen from Jefferies. Please go ahead.

[Jon Petersen, Jefferies]

Hoping you guys can maybe talk a little bit about expectations around the election specific maybe just high level if there is 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 be thinking about the impacts of that if it does. And there has also been talk about Biden [ph] getting rid of 1031 exchanges and just curious if you have any thoughts on what that would do to evaluations and transaction volumes for the warehouse space?

[Eugene Reilly, Chief Investment Officer]

Yeah it's Gene, I'll take the Prop 15 and probably take the other question Tom. So with respect to Prop 15 first of all, we've to see passes, the polling looks right now like it probably won't pass, but if it does, there are a few things to keep in mine. 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 and of course this has passed through revenue to customers 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 rent growth, but we got to see if this passes first. And on 1031, Tom will take that.

[Thomas Olinger, CFO]

Yeah I'll take that. 1031s are very embedded in real estate transactions. As I think it's been around for almost a 100 years, but I think there is reason why we think clearly manage in fact 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 thought we're going to be extremely patient. We're very under-levered, but frankly under-deployed a bit. We're 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 ratios in the low 60%, close to 60% this year and we're generating about $1.1 billion of excess cash flow.

So what would happen at the 1031 exchange? If eliminated right, our taxable income could go up to the extent we sold assets and capital gaining component of our dividend would increase and that would upward pressure on our dividend, but you can read that significantly well payout ratio and we're generating $1.1 billion free cash flow. So while we utilize it, we can certainly manage around it.

[Hamid Moghadam, Chairman and CEO]

I think the bigger issue have been the two specific things you asked about is that California is becoming increasingly 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 California better get it back together because otherwise they're going to kill the base and that is a concern for everybody. Having said that, it is the world's largest, the fifth largest economy and continues to be the center of innovation and a lot of adventure in the world. So we model through but sure the politicians they're making it very difficult for this economy to remain competitive. So that's much more concerning than our 1031 specifically at least to me.

[Operator]

Our next question comes from David Rodgers from Baird. Please go ahead.

[Dave Rodgers, Baird]

Tom, as we follow up on maybe those earlier comments that you made about the K shape recovery and that lower leg of the K that everyone's trying to figure out, is there a way you can give us straight-line rent right off that you've seen in the third quarter and year to date to kind of provide some color on that? And maybe just to follow-up on the deferral it think you said 95% have been paid to date.

Can you give us a rundown just on the level of direction of the deferral that you think might 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.

[Eugene Reilly, Chief Investment Officer]

Sure Dave, thanks. So on your first one just regarding straight-line rents, those are netted down again termination fees. So when you see a termination fee, those are net of those. Listen it's termination fees are probably about where it's $3 million in the quarter if you looked over a long period of time. I don’t have a precise number, but it's a straight line of that component of $1 million net of it. So it's calculated, we certainly take into consideration and the fact that calculation as well.

Regarding deferrals, I've been very happy with deferral collection. So we build deferrals. To date are about $40 million of the deferrals, it's 61 basis points of annual growth rent. We've build two $20 million of that or half of its due. We collected 95% of that already. Most of that's 5% to collect is really in October, but it's trending very normally with prior months. So I'd expect the vast majority of all that to come in.

Of the $40 of deferrals, we'll build 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 of the end of the year. So I think this should be wrapped up by the time we get to the end of the end of year. We'll have some of that evolving to '21 but if they're get taken care of and due to our stock feel very good about collections and very good about deferrals.

[Operator]

Our next question comes from Mike Mueller from JPMorgan. Please go ahead.

[Mike Mueller, JPMorgan]

If you look at upcoming development starts into 2021, are there any significant seismic and graphical devices to the pipeline?

[Eugene Reilly, Chief Investment Officer]

This is Gene. 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 it's becoming even more broad-based. So I really don't think there's any particular market.

Our product I call out, obviously there's some very significant strength in the big-box sector and we're going to need to have demand, but I don't think the composition of the deals looks much different than for example they did last year. Chris?

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

I'd say in Europe, France and Poland are going to be low on that list. It's been some places where I expect less trend line development and I think Japan is going to be busier given the strength of those markets.

[Operator]

Our next question comes from Tom Catherwood from BTIG. Please go ahead.

[Tom Catherwood, BTIG]

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 is kind of broad-based demand center for certain tenants, but is the lagging occupancy and rent growth have to deal with the K-shape 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?

[Thomas Olinger, CFO]

It's the former and frankly that smaller spaces have two kinds of tenants and they have big tenants in smaller spaces where they're more closer industry issues and those are just feeling fine and then there are smaller spaces, smaller businesses that are more vulnerable to this economic downturn and therefore there is 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 as the data that goes by, the survivors are surviving all the odds. So I expect that to decline.

The problems in these small spaces and the small tenants the decline and at some point it will flip because during 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 moving their businesses will get back little bit. So that will come back but it may be a lag but things are relatively small spaces are just fine, no problem.

[Operator]

Our next question comes from Craig Mailman from KeyBanc Capital Markets. Please go ahead.

[Craig Mailman, KeyBanc Capital Markets]

Maybe just going back e-commerce and as it relates to maybe the US specifically, can you guys throw out what Amazon was and what the PL's 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 with the pipeline looks like, do you have a sense of maybe describe as a way to win that wave crest from a quarter perspective and then kind of hit the peak of that demand and then kind of trails off and how that is impacting potential development starts as you look out, not just for you guys the market clearly you guys are turning spec back on, I am just kind of curious if others are turning spec on in anticipation of this and how that could potentially impact that rent growth as the expectations that past '21 development deliveries would kind of really moderate if that may just not happen given kind of other dynamics going on.

[Thomas Olinger, CFO]

I think we're in the early stages of shipping earlier than mid stages of e-commerce to go up and I think what happened in the last several months is exactly five to seven years of growth. So I don't we're going to give any of that back. I think you going to plateau for a while as people go back to regular shopping and restaurants and uniting at home and all those things and then light backup at a more elevated level. So the big way to keep your eye on is that if the tsunami of e-commerce coming through.

What happened to the ripples on top of that big wave frankly in which quarter, I have no idea honest and it varies market by market. But we don’t run our business based on the ripples on top of the big wave. In terms of our dynamics in the marketplace that could make it difficult for the demand of that wave to be fulfilled, the answer is yes, the most desirable markets are the ones with the tightest land. The most difficult in finding large pieces of flat land that you can build these buildings that e-commerce player's demand etcetera, etcetera.

So with every passing day, we're having more demand for that sector. Now it's elevated and it's stabilizing with 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 there is short supply in the more desirable markets. So I think that's the positive trend.

[Operator]

Our next question comes from Emanuel Korchman from Citigroup. Please go ahead.

[Manny Citigroup]

I think I wanted to come to clearly your view on the asset management business, Tom had made a comment in the opening remarks about your business perpetual and preparing it relative to most of the asset managers in terms of how they're being valued versus how the business within Prologis is being valued? And I think you've shown tremendous amount of creativity in terms of structuring your enterprise leveraging a lot of different structures whether they're external managed entities, leasing funds and centralizing management with part of the compensation structure in that business.

I guess are you thinking about taking one step further in somehow making this entity that are public or a private to highlight that value or do you view this just as within Prologis and we just hope the market would review the appropriate value.

[Hamid Moghadam, Chairman and CEO]

Excellent question and let me just pile on to your question. I think there are two businesses, one is the development business and one of the investment management business, that I guarantee if I took the numbers of our development business and part of use for each family business and by the way, we have those numbers going back to year 2000 okay and show that to your home analyst at Citi, I bet you truly will value at 2.5 times book, with book to development business and a multiple that's more in the team.

And if I did the same thing, the investment management business actually showed 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 am willing to bet you that they’ll put a 25 multiple on the pre-promote number and will give us the present value of the promotes on top of that and net of it is I think both of those businesses are valued at about 30% to 40% of what they should be.

Now that leads to really under my spend and we spend a lot of time trying to figure out what you can do with sections all that kind of stuff. The government issues that come along with that are very difficult and complicated and painful, where do you develop, how do you change where it's done and frankly it doesn’t matter anymore. It's $140 billion enterprise and whether it's 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, the latter statement that we make, we're trying to give enough the complexities are not worth, the incremental value that we may get in the short term. I'm sure we'll better do long time because the evidence it's becoming so indisputable that it's kind of actually meaningful at this moment more than annoying.

[Operator]

Our next question comes from Jamie Feldman from Bank of America. Please go ahead.

[Jamie Feldman, Bank of America]

You were talking about upping your outlook for in the direction to 210 square feet and completions 290 million square feet. Can you just talk more about what you're seeing from taking on REIT competitors in terms of their appetite to speculative development and then also we have this delay in construction, but what does this all look like heading into '21 and given early read on what your supply-demand forecast were quite there?

[Hamid Moghadam, Chairman and CEO]

The answer to your second question is yes. We have an idea whether it will, we will share with you on the next call when we provide guidance for 2021. With respect to non-REIT players, they continue to be by far but they just in aggregate sector of development have always been and will continue to be the better REITs as large as they may be.

I don’t know 20% of the business may be in the more relevant markets. So really the part of my case was vast majority of the 30s and I'd 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, maybe Houston and Poland but by factor of five, it's Poland and maybe somewhere.

And the reason for it is not that these private developers or public developers have forgotten how to build buildings or any less interest in building, and just really cost define the land being had on them to build the buildings of their size that the market demand to meet a lot of this virtually demand from the big day commerce.0 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 advisory large pieces of land in the desirable markets and our belief that the West Coast and all that are initially three to four years on large pieces of land and you got to jump through all kinds of needs and complexities. So it becomes difficult to tie up with this piece of land to take it through their impediment process. We get a lot here a lot there and it's just difficult. So that's what I would say about it.

[Operator]

Our next question comes from Caitlin Burrows from Goldman Sachs. Please go ahead.

[Caitlin Burrows, Goldman Sachs]

Hamid, I think before you mentioned that there is a lot more people showing up at it relates to the transaction market. For Prologis' 2020 guidance it would increase I think now it's $750 million estimate point from $600 million originally and lower than that last quarter. So could we just talk about the current transaction market and how those two pieces wind up? It seems Prologis is more confident on your ability put in that commentary that there are a lot more players?

[Hamid Moghadam, Chairman and CEO]

There are a lot more players and our acquisitions are not sort of the no brainer acquisition that are a race to who accepts the lowest IRR. Just to say that there are lesser business. We're not in that business. We show up that every one of those options to get people on that been going on but honestly that they're not buying a whole lot of clean perfect brochure quality. I think the pipeline market on some of those things that we've seen recently just beyond ridicule.

I think most of our volume comes from more infill, more reposition plays, last touch plays, urban plays. So the stuff that the ratio of the cost of money to the level that we're compelling you towards level of effort and talent and customer relationships. So we know 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 the people who really like that business and there seem to be more and more of them every day.

But we have great visibility and as you know you may remember that people always ask me about acquisition guidance and I say I'm $0 billion to $10 billion and we've exceeded the top end in the path and we've been zero at the time. We don’t have a budget for acquisitions because it all depends on pricing and availability and quality of properties. You can make your acquisition guidance Q1 as we hear, but it would not be equivalent thing to do it.

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 of the fourth quarter next year and that's what's the recent confidence to increase those numbers. They're mostly high effort value-added types of things, not that passive and no brainer.

[Hamid Moghadam, Chairman and CEO]

Caitlin, I think that was the last comment. So I want to thank everyone for attending our call and we look forward to meeting with you in the new year and sharing our 2021 guidance. Thank you.

[Operator]

Ladies and gentlemen, this does indeed concludes today's conference call. Thank you again for participating. You may now disconnect.