Q3 2012 Earnings Call
October 23, 2012 12:00 pm ET
Hamid R. Moghadam - Chairman of the Board, Co-Chief Executive Officer and Member of Executive Committee
Walter C. Rakowich - Co-Chief Executive Officer, Director and Chairman of Executive Committee
Thomas S. Olinger - Chief Financial Officer
Eugene F. Reilly - Chief Executive Officer of the Americas
Gary A. Anderson - Chief Executive Officer of Europe and Asia
Michael S. Curless - Chief Investment Officer and Chairman of Investment Committee
Brendan Maiorana - Wells Fargo Securities, LLC, Research Division
Chris Caton - Morgan Stanley, Research Division
Jeffrey Spector - BofA Merrill Lynch, Research Division
Michael Bilerman - Citigroup Inc, Research Division
Craig Mailman - KeyBanc Capital Markets Inc., Research Division
Steve Sakwa - ISI Group Inc., Research Division
David Toti - Cantor Fitzgerald & Co., Research Division
John Stewart - Green Street Advisors, Inc., Research Division
Ross T. Nussbaum - UBS Investment Bank, Research Division
John W. Guinee - Stifel, Nicolaus & Co., Inc., Research Division
Michael J. Salinsky - RBC Capital Markets, LLC, Research Division
Michael W. Mueller - JP Morgan Chase & Co, Research Division
James C. Feldman - BofA Merrill Lynch, Research Division
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Thank you, Sarah, and good morning, everyone. Welcome to our third quarter 2012 conference call. The supplemental document is available on our website at prologis.com under Investor Relations.
This morning, we will hear from Hamid Moghadam, Chairman and Co-CEO, who will comment on the macroeconomy and market condition; and then from Tom Olinger, CFO, who will cover results and guidance. Additionally, we are joined today by members of our executive team including Walt Rakowich; Gary Anderson; Mike Curless; Nancy Hemmenway; Guy Jaquier; Ed Nekritz; and Gene Reilly.
Before we begin our prepared remarks, I'd like to quickly 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. I'd like also to state that 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 reconciliation to those measures.
[Operator Instructions] Hamid, will you please begin?
Hamid R. Moghadam
Thank you, Tracy. Good morning, everyone, and welcome to our third quarter call. Let me start by saying how pleased I am with our results, which are the strongest for our company since the start of the global financials crisis. We'll keep our prepared remarks brief, as you just heard from us last month at our investor forum. Our focus today will be on the macroeconomy, realtime market conditions and our operating results.
First, let me offer some observations at the economic indicators that most affect our business. Global trade volumes remain well above peak and the IMF forecast growth of over 3% for this year and 4.5% for 2013. Consumption is strong, with retail sales coming in at over 5.5% year-over-year and online sales growing 3x faster. Real inventories have increased with an annual rate of 3% this year.
Interestingly, inventories are the only major economic indicator that remains low peak by about 3%. We think there is ample room for growth in inventories as consumer confidence improves. The increase in consumption and the rebuilding of inventories is translating into further improvement in the operating environment. Net absorption in the U.S. was positive for the quarter at 20 million square feet. While this is slightly below our forecast, it's worth noting that new supply also came in below our forecast. Deliveries in the quarter represented a fraction of the obsolescence rate. For the fourth quarter, we expect a healthy level of absorption around 50 million square feet, which is in line with normal seasonal patterns.
Looking to 2013, we expect 160 million square feet of total absorption. Next year's forecast may prove to be conservative as it doesn't account for a housing recovery, which appears to be in its early stages.
In terms of what we're hearing from our customers, the majority of our global markets, customers are confident about their prospects for the fourth quarter. We think this bodes well for the holiday season. As they look to 2013, our customers continue to focus on operating efficiencies and growth from e-commerce. Same-day delivery may be coming sooner than we all thought. Space utilization is very high, and the simple fact is that the number of our customers are no longer able to delay the business around space procurement. They're at the point of needing to press forward with new facilities, and we're seeing this in our high-level build-to-suit activity.
Turning now to our third quarter results, our teams around the globe did an outstanding job leasing a record 39 million square feet in our operating and development portfolios. A real bright spot has been leasing in units less than 100,000 feet. Occupancy in these smaller spaces was up 80 basis points in the quarter and 270 basis points year-over-year. This segment is closely tied to the housing market.
Growing demand and increases in occupancy are also having a positive impact on rent. In fact, we expect rents on rollover to turn positive in the next quarter and remain positive throughout most, if not all, of 2013. The lack of supply and increasing rents are driving our development starts, especially for larger buildings. During the quarter, we started 10 new projects globally, 2/3 of which were build-to-suits. Our margins on year-to-date starts are roughly 19%. While we don't expect to sustain this level of profitability over the cycle, these trends clearly support the value of our land make. Of course as conditions improve, new competitors will enter the markets we already serve. This will be challenging for them because the global markets have high barriers to entry. Lending policy changes such as Dodd-Frank and the new Basel III will require incremental capital charges that are up to 50% higher for real estate construction loans relative to traditional corporate lending. In fact, we are already seeing lenders adopt these new risk-based capital rules with more conservative lending standards. Changes in lending policies will impact new deliveries. We believe this cycle will be different as these new lending requirements will place a governor on overbuilding by merchant developers, who simply won't be able to secure funding for new construction.