Prologis Inc. (PLD) Q3 2022 Earnings Call Transcript

Prologis Inc. (NYSE: PLD) Q3 2022 earnings call dated Oct. 19, 2022

Corporate Participants:

Jill Sawyer — Vice President, Investor Relations

Tim Arndt — Chief Financial Officer

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

Michael S. Curless — Chief Customer Officer

Dan Letter — Global Head of Capital Deployment

Christopher N. Caton — Senior Vice President & Global Head of Research

Analysts:

Steve Sakwa — Evercore ISI — Analyst

Craig Mailman — Citi — Analyst

Derek Johnston — Deutsche Bank — Analyst

Nick Yulico — Scotiabank — Analyst

Michael Goldsmith — UBS — Analyst

Ki Bin Kim — Truist — Analyst

Tom Catherwood — BTIG — Analyst

Vince Tibone — Green Street — Analyst

Todd Thomas — KeyBanc Capital Markets — Analyst

Blaine Heck — Wells Fargo — Analyst

Ronald Kamdem — Morgan Stanley — Analyst

Camille Bonnel — Bank of America — Analyst

John Kim — BMO Capital Markets — Analyst

Jon Petersen — Jefferies — Analyst

Anthony Powell — Barclays — Analyst

Michael Carroll — RBC Capital Markets — Analyst

Michael Mueller — JPMorgan — Analyst

Dave Rodgers — Baird — Analyst

Bill Crow — Raymond James — Analyst

Jamie Feldman — Wells Fargo — Analyst

Presentation:

Operator

Greetings, and welcome to the Prologis Third Quarter 2022 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the call over to Jill Sawyer, Vice President of Investor Relations. Thank you. You may begin.

Jill Sawyer — Vice President, Investor Relations

Thanks, Daryl, and good morning, everyone.

Welcome to our third quarter 2022 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 in 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 other 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. On October 3, we closed on the acquisition of Duke Realty. As a reminder, Duke’s results are not contained in our third quarter earnings release. However, within our supplemental, we included a summary of the portfolio integrated as of quarter end. Please refer to our website for details on the transaction.

I’d like to welcome Tim Arndt, our CFO, who will cover results, real-time market conditions and guidance. Hamid Moghadam, our CEO, and our entire executive team are also with us today.

With that, I’ll hand the call over to Tim.

Tim Arndt — Chief Financial Officer

Thanks, Jill. Good morning, everybody, and thank you for joining our call.

We are clearly in a volatile macro environment, where ongoing inflation, steeply rising interest rates and the war and energy crisis in Europe are pressuring the global economy. And while we’re closely monitoring each element, the fundamentals in our business are very strong, and our read of supply and demand in our markets remains out of sync with the headlines. This morning, we reported excellent third quarter results, which generated many new records in the quarter. We will spend less time on these results and more time describing our view of the market and how we’re navigating the environment.

Before doing so, I’d like to thank our teams across the entire organization who did an exceptional job keeping focus on the business, especially while working through the Duke acquisition, which closed on October 3. We fully integrated the portfolio, achieved our day 1 synergies and look forward to the next phase, which is to build AFFO accretion through incremental property cash flows and Essentials income. We move forward with a better portfolio, a larger and stronger balance sheet, talented new employees and new customers to whom we can introduce to our Essentials business.

Turning to results. Core FFO was $1.73 per share, including $0.57 of net promote income earned principally from our PELP venture in Europe. Our annual guidance for Promotes was $0.60, with most of the revenue to be earned in the third quarter. The amount came in below expectations due to a nearly 5% write-down of European asset values in the quarter, partially offset by an increase in NAV from debt mark-to-market. In the end, the promote was a record high, while the fund enjoyed a high teens annualized IRR across the 3-year performance period despite the recent markdown.

I’ll note a few operating stats from the quarter, all of which were records for the company. Ending occupancy increased 10 basis points over the quarter to 97.8%. Same-store growth was 8.3% on a net effective basis and 9.3% on a cash basis. Both were driven primarily by rent change, which was 60% on a net effective basis. Separately, the Duke portfolio ended the quarter with 99% occupancy and net effective rent change of 54%. While these markets are outstanding, they are also backward looking. So we’ve kept focus on more contemporaneous data, namely rent change on signings, which was 84% during the quarter, and our lease mark-to-market, which now stands at nearly 62%.

Finally, we had a very active quarter on the balance sheet, raising over $3 billion of debt in a variety of markets and currencies given our broad access, including a $650 million green bond issued in late September. We ended the quarter with debt-to-EBITDA of 4.3 times, excluding gains, providing us significant investment capacity.

Turning to our observations of current conditions. We continue to see scarcity of available space across our markets. Vacancy rates are at historic lows, and our own occupancy sits at a record high. Market rent growth in the third quarter remained robust in response to this scarcity and continued strong demand. Color across the markets remains generally upbeat in terms of customer inquiries, and our proprietary metrics also reveal healthy activity even if they’ve softened from the peak demand generated during COVID to levels still above long-term averages.

Transaction gestation was stable during the third quarter at 62 days, proposals via available units slowed during the third quarter to levels more in line with the pace of 2019 and indicative of less urgency to renew space far ahead of exploration. Inside our properties are metrics point of activity that is increasing with our IBI index at 63.8%, the 80th percentile and utilization up to 86.6%, the 95th percentile. Our certain customers have publicly announced a pause in capex spending, particularly those with more mature supply chains. But active dialogue with the majority of our customers confirms an overarching need to increase space as supply chain resiliency remains a top concern.

Shifting to supply. We’re seeing initial signs of a deceleration in development activity across our markets as construction and capital costs continue to increase. We believe we could see a gap in deliveries emerge in late ’23 or early ’24. As for today, our true months of supply metrics sits at a healthy 22 months, up from 18 months last quarter. We’ve previously explained that we expect to see this metric climb into a low 30 months range, still at a level reflecting a strong operating environment.

It’s important to acknowledge where supply is being delivered as our submarket location strategies minimize our exposure to new supply. For example, in our coastal US markets where we generate over 50% of our global NOI, vacancies are just 1.7%. Geographically, we have an increased level of focus on Europe given the ongoing war and growing energy crisis. While we’re reporting record results, including occupancy at 98.6% in a market with 2.4% vacancy, we are closely monitoring conditions. Customers are exercising caution in response to rising energy costs, which may create headwinds to near-term demand. That said, we also believe that new supply will now decline around 15% in 2023, which should support occupancy.

The US remains strong, where we now generate 87% of our NOI with the addition of Duke. Our teams continue to see solid activity, although acknowledging a reduced number of prospects for space compared to what we saw during the frenzy of COVID. Rent change on signings during the quarter was 93%, demonstrating a continuation of favorable pricing dynamics.

In Latin America, both Mexico and Brazil are performing well, with very high occupancy over 98% and rent change across the region of 24%. And in Asia, construction costs in Japan are rising most acutely from the weakness in the yen, as well as from competition for key materials to complete construction. Market vacancies have increased, but this constraint on new supply, particularly out to ’23 and ’24, should provide an offset. The combined picture was positive to third quarter market rent growth, exceeding our expectations and driving a 300 basis point increase of our ’22 global forecast to 26%, with the US at 28%, significantly up from the 10% and 11%, respectively, in our initial guidance.

It’s difficult to fully know the impact of this market rent growth on values given the limited transaction volume in the market. But our view is that the increase in return requirements is more than offsetting rent growth and indeed pressuring values. Based on prior cycles, we can safely assume it will take few quarters for full price discovery to be made as markets stabilize and transaction volumes build.

With all this in mind, we’re carefully managing the business and approaching our markets with a sense of caution much as we did at the onset of the pandemic. In leasing, despite the very strong spot environment, we are carefully watching for softening demand and will assume that there will be further macro deterioration. In some markets, this will have us managing more for occupancy than rent growth, but in many others, we believe pricing will remain favorable given very low availability. This is an environment where our revenue management capabilities will be the most useful and allow us to manage such decisions lease-by-lease.

With deployment, we are reducing our starts guidance to a range of $4.2 billion to $4.6 billion, and we expect our fourth quarter starts will be 60% build-to-suit, reflecting a more cautious approach to deployment in the coming months, aiming to be very selective in new projects. And in terms of strategic capital, we previously mentioned that we expect to see an increase in redemption activity. While we did have inflows from numerous investors, redemptions grew by $1.3 billion, which, for context, is just 3% of our open-end third-party AUM.

Our funds have sufficient equity queues to address this activity. In combination with equity called during the quarter, we now sit at net neutral queues. The open-ended funds have ample investment capacity based on overall low leverage, and we are optimistic about the long-term growth of the business. In the near-term, we will be prudent as we evaluate further capital deployment, including a pause on contributions in the short-term.

Turning to guidance, which includes Duke portfolio for the fourth quarter. We are maintaining our guidance for average occupancy, while increasing our net effective same-store guidance to 7.5% to 7.75%, and our cash same-store guidance to 8.5% to 8.75%. We expect to see our lease mark-to-market around 65% at the end of the year. We now expect acquisitions to range between $1.9 billion to $2.1 billion, which increased due to our acquisition activity in Europe during the quarter, and contributions and dispositions to range between $2.1 billion to $2.3 billion.

Finally, we are increasing core FFO, excluding Promotes, to $4.60 to $4.62 per share, which includes approximately $0.05 of accretion related to the acquisition of Duke. We are guiding core FFO with Promotes to be $5.12 to $5.14 per share, which incorporates a lower Promote guidance of $0.52, reflective of the higher share count resulting from the Duke transaction.

I’d like to point out that our earnings have been unimpacted by FX over this extremely volatile year due to our capital strategy and approach to hedging. The same is true for our equity base, which has very minimal exposure outside of the US dollar despite our global footprint. We will continue to protect both proactively and programmatically.

To close, we’re proud of how we’ve positioned the business and are optimistic about the organic growth ahead. We own hard assets with contractual revenues, significant embedded mark-to-market and have meaningful secular drivers that continue to play out. As an organization, we have long had an entrepreneurial and growth mindset. Today, adding new business lines and cash flow streams that are synergistic with our already unique model. We have built the company to thrive across cycles, including uncertain environments like today, where we can seize opportunities and continue to set our business and portfolio apart.

We’ll now turn the call over to the operator for your questions.

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from the line of Steve Sakwa with Evercore ISI.

Steve Sakwa — Evercore ISI — Analyst

I don’t know, Tim or Hamid, I guess what I’m trying to sort of circle up here is that, I understand why development starts would come down in light of what’s going on globally, but yet stabilizations are up but the contributions are down. And I guess what I’m trying to really square up is if the funds still have capacity and they’re still interested in deploying money, I’m trying to just really circle up why contributions into funds would be down, which is also impacting development gains? So is it a pricing issue? Is it a lack of leasing on the assets? I guess, I’m just trying to get a little more color on why that contribution number is down. And I guess I can understand why dispositions would be down in this uncertain capital markets environment, but I’m just trying to get a little bit better handle on the contribution side.

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

Yes, Steve, good question. It’s actually none of those reasons. The reason the contributions are down is that I made a decision that we are going to stop contributions until we have much better clarity on valuations, because one of the lessons that we and the former Prologis learned in the last cycle is that it’s really, really important not to force any issues when there is the least bit of hesitancy around values. And as much as we have ideas about what values are and where they’re going, we don’t have absolute certainty about that. So it was completely a voluntary decision. Our leasing of our development business is actually ahead of what the way we underwrote the properties, and there is no external constraint on us, including capacity of which the funds continue to have some. They’re getting some redemptions, but they have plenty of leverage capacity, and we continue to raise money even in the same environment, not as much as we did before, but we continue to do that.

Tim Arndt — Chief Financial Officer

I would just add, Steve, in relation to your comment on gains in next year, I would just point out that the value creation is occurring regardless of that monetization event. If we hold the development assets on our balance sheet, it’s still there at a very attractive yield. And we believe many of those assets will still find their way to the fund. It’s just a time, a pause right now.

Operator

Our next question comes from the line of Craig Mailman with Citi.

Craig Mailman — Citi — Analyst

I just want to go back, Tim, to your commentary, there was, I think, an overarching message that fundamentals are still very strong. And the way it looks to me, you could still have accelerating core growth into next year. But at the same time, you clearly mentioned that some markets you guys would have to be kind of revenue managing here. I just kind of would like a little bit of color on maybe the percentage of those markets or how we should think about what’s really at risk from a fundamental perspective? And then also, just as it relates to Duke, clearly, debt rates have moved against you a little bit. And so relative to your initial accretion, there’s probably a little bit of a headwind there. And I’m just curious, too, as you guys kind of start to bid and kind of coming down a bit this year, where is your updated accretion number for Duke for the first 12 months?

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

That was a couple of questions and 1 big question. So let me take parts of it, and I’m sure Tim and Dan will have a follow-up on this. In terms of fundamentals, what we’re saying is that if a normal range of market outcomes is kind of 0 to 10, we were operating in an environment that was maybe at 12 for the last 18 months, and that’s coming down to sort of a 9, 9.5 today. And that’s why we shared with you the percentiles of utilization and occupancy and business activity that are part of our proprietary data that we survey customers around. So by any measure, other than the last 18 months, I would say, we’re in very strong market conditions.

And during those periods of sort of 9, 9.5, there are always a couple of markets that are weaker than others. The key markets are exceptionally strong. I mean, LA, basically LA and Inland Empire, there’s no vacancy in New Jersey, there’s no vacancy and so on and so forth. But there are markets where vacancy rates are in the 5%, 6% range. That’s by historical standards. It’s a very low level of vacancy. So I would say — I would characterize the fundamentals as being very, very strong. They’re just not off the charts given what’s happened in the last 18 months.

With respect to the Duke portfolio and margins and the like, Dan can elaborate on this, but we’ve never underwritten the exit cap rates to what the peak has been in the last 12 to 18 months. We’ve always taken — added the premium for the forward risk and just the fact that, basically, these were unprecedented times. And a lot of the margins that you saw in prior quarters from us reflected that level of conservatism. And rents are still going up. I mean, we started 2022 thinking rents are going to be up 11%. They’re up 28%. So yes, cap rates have gone up, but the rents that are being capped are significantly higher.

So bottom line, margins, if you really stress test everything, okay, and you say rental growth stops, cap rates go up, et cetera, et cetera, construction costs go up, our development pipeline goes from mid-40s margins to high 20s margin type of thing. So we’re still double what we underwrite to, which we usually underwrite to mid-teens. So extremely strong operating environment, and we are just being cautious on the capital market environment as we have to be. It would be imprudent if we weren’t.

Tim Arndt — Chief Financial Officer

And Craig, I’ll just pick up your question on the debt in Duke. You’re right. Since we announced the transaction in June, depending where you’re on the curve, we’re 100 to 200 basis points higher in interest rates. So that does hit the debt mark-to-market piece of things. I think if we were redoing the entire accretion on the year, we’d be still in the range, but at the lower end of that original $0.20 to $0.25 today.

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

Yes. But I would also say on the fundamentals of the real estate, we’re ahead of where we underwrote. So I think that far outweighs a mark-to-market on the debt. I mean, both Duke and us were very low levels of leverage. So the mark-to-market is just not a big deal in our calculus.

Operator

Our next question comes from the line of Derek Johnston with Deutsche Bank.

Derek Johnston — Deutsche Bank — Analyst

Just touching on European occupancy. You certainly had a positive bump to 98.6% and clearly pushed NOI. But can you expand on which geographies led really the sustainability of EU demand, what you guys are seeing on the ground and any additional leasing comments?

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

Some of the weaker markets in Europe have strengthened, like Spain would come to mind or France would come to mind. The perennial strong markets in Europe were the UK and Germany, historically, Northern Europe. And they remain strong, but we wouldn’t be surprised if Germany weakened a bit and the UK weakened a bit. In terms of weak markets in Europe, I would say, if you really force me to name one, I would say it’s Hungary, which is a very, very small part of our overall business. Poland is actually, too much to our surprise, pretty strong. It must be because of the migration of a lot of Ukrainians into Poland and the additional consumption that they drive. But markets in Europe are tighter than they are in the US in aggregate, and that’s why vacancy rates are lower. But there’s no question that Europe will have lower growth or more if we go into a recession, a bigger recession than the US, but by no means is it weak. Quite to the contrary, pretty strong.

Operator

Our next question comes from the line of Nick Yulico with Scotiabank.

Nick Yulico — Scotiabank — Analyst

I just wanted to touch on sort of thinking about as we are heading into a weaker economic environment, most people think there’s a global recession coming. If you could give us some context of how to think about potential occupancy impact to the portfolio. I mean, I think most of the third-party brokerage firms are citing something like 100 basis points of US vacancy increase next year because of slowing absorption, some supply picking up. I guess, I’m curious what you thought about that. And then also from a credit loss standpoint, how we should think about the portfolio in sort of a historical context, kind of framing out where you have sort of a credit watch list today and potential occupancy impact on top of just an overall market occupancy impact from a credit loss standpoint in the portfolio if we are heading into a recession.

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

Sure. On credit loss, the average over 10, 15 years has been about 15 basis points. We underwrite a lot higher than that, but that’s where we’ve averaged during the most acute times of COVID in the first quarter or 2 when nobody — when there was all that lots of jobs and everybody was scared. That went up to 55 basis points. But we collected on all that credit reserve that we had set up because eventually everybody paid. So I don’t know where we ended up with, but we essentially ended up at 0, or maybe in line with the 15 basis points of historical numbers. I don’t think we’re going to see it anywhere near that. I think there is a fair amount of demand today that is not being satisfied in the market because of lack of supply.

Our vacancy rate, just to pick a round number of 4%, even if they were to go up 100 basis points, which I don’t believe they will, it would be at 5% which we would all do cartwheels for at any time in the 42 years that we’ve been in this business. So I’m — I mean, just do the math on the numbers, assuming that the development pipeline has a 0 more leasing. I don’t mean for Prologis, I mean for the marketplace. And demand falls off significantly. That’s how you get to the 100 basis points. And I just don’t think it’s going to be that acute given what we’re seeing in terms of customer interest in our spaces on a real-time basis.

Operator

Our next question comes from the line of Michael Goldsmith with UBS.

Michael Goldsmith — UBS — Analyst

My question is on the Promote. I think heading into the year, we talked about 2020 to 2023 Promote being similar or higher than where it was going to be in 2022, just given where valuations have changed and the different dynamics at play, how should we be thinking about the dynamics at play for next year on the Promote side?

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

Promote levels are very sensitive to exit cap rates that you assumed. So that’s a pretty tough question to answer. But if we stress test our numbers from the last time we spoke, the Promote for USLF next year is going to be on par with what it is this year for PELF. But that number can move in either direction by a significant amount, depending to what happens to exit cap rates. And by the way, both of those years, ’22 and ’23, will be record Promotes by a factor of 2 or 3.

Operator

Our next question comes from the line of Ki Bin Kim with Truist.

Ki Bin Kim — Truist — Analyst

I just want to go back to the question about contributions and your fund business. Can you remind us what the pricing mechanism is for your funds for you to contribute assets? If I remember correctly, that was a broker pref, but obviously, you don’t want to force anything into your fund investors. So I’m just curious, what is causing the pause or temporary pause in contributions? Is it just an agreement or agreed upon price that you can’t come to or is it something different? And second question, Hamid, if I think about the business bigger picture, if we didn’t have this market volatility, I would have expected your company to contribute an increasing level of assets to your fund business because you have to kind of keep up with the development pipeline. But given that that’s probably not going to happen, how should we think about the company taking on more assets on the balance sheet, better for our earnings but also higher leverage? I’m just trying to better understand that dynamic going forward.

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

Yes. On the fund contribution question, we would be happy to continue to contribute the deals. If there were not for our care in managing the long-term value of the franchise in our private capital business. We haven’t even tried, and we will not even try to contribute these assets that are being completed because we just don’t think it’s the right thing to do. It’s got nothing to do with the appraised values or capacity or any of that stuff, as I explained before. We just think until there is real clarity, that will take some time and there have to be some comps and some transactions.

Then when there is clarity, we’ll start contributions again. As you know, unlike the last cycle, the contributions today are not must put, must take. They are totally voluntary by us to offer those properties to the investors or not to offer those properties to the investors. We’re just not going to force that issue. It’s not like they’ve turned us down or we think the values are too low. The values are great. We would still have significant 40% margins if we contributed. It’s purely voluntary. And I think it’s the right decision for the company in the long-term.

In terms of its impact on leverage, obviously, if we decide to hold more assets, our leverage is going to go up. But the reason we built this balance sheet is exactly for situations like this, is to be able to, A, be able to hold more of our assets that we’re developing. They’re perfectly good assets that at some point in the future will contribute. And we’re happy to hold those. And the other purpose for the balance sheet is to take advantage of investment opportunities as they emerge. It’s still too early because I think the valuations will settle out somewhere lower than where the appraisers probably think today. But I don’t know that for sure.

And we — by the way, we’ve been — don’t listen to a word I’m saying with respect to valuations, because for 5 years, we’ve been saying the cap rates are going to go back up, and they finally did, I guess. But we’ve been really wrong and, frankly, too high in cap rates for all this time. One other thing that’s important, I should have mentioned this. We had never written up our portfolio so the peak cap rates are underwritten any of our developments to the peak cap rates that we were seeing in the marketplace. We were always assuming exit cap rates that had a premium built into them. I think I mentioned that before, but that premium was anywhere between 5,000 to 7,500 basis points. So a lot of what you’re seeing and are yet likely to see in values is already reflected in the way we looked at our margins, and we further stress test those numbers. And I think I shared the results of that with you earlier.

Operator

Our next question comes from the line of Tom Catherwood with BTIG.

Tom Catherwood — BTIG — Analyst

Hamid, you mentioned tenants with more mature supply chains have slowed their capex spending. Obviously, we’ve seen that in the headlines as well. Are you seeing, though, any givebacks or nonrenewals from those tenants, whether it’s FedEx or Amazon or others? And specifically, what are the tenants or industries that are backfilling this gap in demand?

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

I’m going to let Mike give you a broader view of demand other than the customers you asked about. But let me hit those 2. We have 0 givebacks on Amazon. Zero. We thought we were going to have 2 out of like 160, we have 0. And they continue to take new space from us. So I don’t know what all this excitement is all about, but we haven’t seen it in the marketplace. They were on a tear in 2020 and ’21, and they probably overcommitted to space, and they just reeled that back a bit. But they talked about 30 million feet coming online. We don’t think it’s even going to be 10 million feet and none of it is in the spaces that we have. So that’s Amazon. FedEx is consolidating some of its ground operations with airport operations. We’re going to be a beneficiary of that. And we’re not going to lose any FedEx business as a result of that. And we’re in regular conversation with these people. So those 2 customers specifically, no issue, and we have vetted this about as best as anybody can.

With respect to the broader customer picture, Mike?

Michael S. Curless — Chief Customer Officer

Yes, I would just add a finer point to that. We’re going to see other headlines coming down the pike. I’d encourage you to really look through the headlines and understand the numerator versus the denominator in play here. And we’re talking, just to pile on Hamid’s comments, FedEx mentioned order of magnitude of 100 projects they’re pausing in the future. That’s set against 15,000 spaces they already have. Amazon, to put a finer point on that, even if there — they have 550 million square foot portfolio. So we’re talking 1% churn kind of numbers here, which is a very normal churn we see for our larger customers that have thousands of spaces. I think it’s important when you see the next headline to look beyond along those headlines.

In terms of where the other activity is, and Chris can pile on as well here, too, but e-commerce clearly is the big driver. And we’re seeing e-commerce levels in our own portfolio just ahead of where we were pre-COVID. The big difference is Amazon is not a part of that this quarter. They’re temporarily pausing, and we’re seeing 122 other customers, not named Amazon, driving e-commerce leasing at levels we saw pre-pandemic. I think that’s the big driver, the big takeaway for the segments that are supporting this backfill.

Operator

Our next question comes from the line of Vince Tibone with Green Street.

Vince Tibone — Green Street — Analyst

You increased your market rent growth forecast in the US to 28% this year. How much of that growth has already been achieved through the end of the third quarter? I’d like to hear just how much you think market rents can continue to grow in the current environment.

Tim Arndt — Chief Financial Officer

Vince, yes, the increase is exclusively based on the outperformance in the third quarter. We thought in the present landscape, it would not be appropriate to make an increase. But as we look into next year, I think it’s appropriate to expect mid- to high single digits. As Hamid mentioned, we opened this year with a similar level of caution and have seen subsequent increases. We monitor this on a real-time basis although reporting out on a quarterly basis. And some of the things that go into that is the ongoing significant momentum, right? So rents were up 6% in the quarter against ultra-low vacancies, healthy demand, healthy leading indicators, but set against the macro uncertainty that we’ve described.

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

So 75% to 80% of the 28% has already occurred, and we expect the balance to occur in the balance of the year. And by the way, we’re only a couple of weeks into the quarter. But again, every time we make a deal, we know what the effect of rent is compared to the way we underwrote it. And we call it spear, I won’t get into the details of it here. But those indications are up, both in terms of comparison to underwriting or the way we had pro forma those spaces. And also in terms of duration of leases, they’re slightly longer than we thought.

Operator

Our next question comes from the line of Todd Thomas with KeyBanc Capital Markets.

Todd Thomas — KeyBanc Capital Markets — Analyst

I wanted to follow up on Duke. Tim, thanks for the update around the $0.20 to $0.25 of year 1 core FFO accretion. But I’m curious, Hamid, your comments suggest that Duke is running ahead of your initial underwriting. So I’m curious if there’s been any change to your underwriting such that the year 1 AFFO impacts changed at all relative to your initial expectations. And then just secondly, regarding the core FFO guidance, excluding net promote income, can you just help us bridge that 1.1% increase at the midpoint from the prior guidance now that Duke’s closed and just discuss the drivers of that increase a little bit? It sounded like the quarter came in ahead of budget or plan, which I suspect contributed, but the increase of $0.05 at the midpoint, I think you attributed solely to Duke. Was there anything else that was an offset in the quarter to the stronger growth?

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

Yes. Just I remember, Duke’s leases were longer than ours. So the average turnover based on the average duration of the Duke leases is like 10%, 12% a year. I don’t remember what it is exactly in the next 12 months that your question was on. And we think we’re a couple of points ahead. But a couple of points ahead affecting 10% to 12% of the portfolio for an average of 6 months is what we’re talking about in terms of its impact on the next year. So it will be a small impact. I think the bigger impact will be what we can do once we get our hands on the rest of the portfolio rolling over through revenue management. And we think overall, maybe that could be 2% or 3% above underwriting. I also think there will be a couple of hundred basis points pickup in terms of folding essential sales on top of that. But it will take a little while for us to sort of build those relationships with those customers in those locations and all that.

On the second part of your question, Tim will address that.

Tim Arndt — Chief Financial Officer

Yes, you’re right that the quarter was strong. We’re probably $0.01 ahead there, and that would be reflected really in the same-store guidance overall that we took up. We would see an uptick on the year from that uplift as well as we would get a little bit out of this slowdown in contributions in the short-term. Offsetting each of those, putting the group to about 0 would be a little bit higher interest expense. We’ve got short-term rates have really ticked up. And then the write-down of asset values in the funds does hit asset management fees. So that would be another take. So that’s all coming up to about 0, leaving really the entirety of the accretion to the Duke transaction.

Operator

Our next question comes from the line of Blaine Heck with Wells Fargo.

Blaine Heck — Wells Fargo — Analyst

Hamid, can you expand on your thoughts on the broader economy? I think your remarks in the earnings release indicated that you’re preparing for an economic slowdown. Does that include a US and/or a global recession? And how should we think about your development starts in 2023 given that you’ve now added capacity through the Duke transaction but seem to be more cautious here today given macro concerns?

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

Yes. My view of the economy is that the Fed was behind the 8 ball, and they are now really running hard to catch up and they’re going to overshoot in their reaction. And everybody expects these things to have an immediate effect. Look, I’m not as smart as the guys running the Fed, but these things typically have a 2-year lag. So I think we’re going to whipsaw this economy. And there is no reason this economy should be in a recession other than just wanting to wring out this inflation. And this is a personal editorial. This is not a company position, but I believe more — based on what I’m seeing, more of the inflation is actually affected by not that systemic wage price push that we saw in other times of high inflation.

By the way, I was there. When I started my career, the 10-year bond was 14% and prime rate was 22%. But that was a psychology that was built into the marketplace. I think — and it look bulker in October of ’79 to bring that out. But the market had gone 6 or 7 years with that becoming the norm. This is very different. We were just talking about 2% inflation a year ago, and it just spiked up. So a lot of that, I think, is going to dissipate as things normalize and trade flows and the like normalize, but that’s a personal point of view. So I am concerned about inflation. I think the Fed is all going to overdo it. Whether we have a recession or not, I don’t know why people are so focused on this recession question. To me, a 0.25% growth rate in the GDP when the potential is 2%, 2.5% for the US and 1.5% for Europe is a bad thing.

Now whether technically a bunch of smoke will come out of the pipe, that says we officially have a recession, that’s less important, but we are definitely under kind of underperform the capacity of this industry. The consumer is in great shape. The consumer balance sheets are in great shape. So I see a lot of reasons for optimism. I mean, look at all these calls that we were all having a quarter ago. I think the psychology has changed dramatically because of all this aggressive Fed action. So I’ve done a good job of not answering the question. If you had to ask me last quarter what’s the probability of a recession in the next year, I would have told you 90-10. Today, I would go 60-40 or maybe 50-50. I think we’re much closer in the US. I think in Europe, we will go into a very slight shallow recession.

With respect to its impact on development starts, I think the market is undersupplied with space. But we don’t have to make that decision today. We don’t. Every start decision is made deal-by-deal, and we will have the benefit of up-to-minute information and actually some information about the future because we’re talking to prospects. So if we think the prospects are there to lease it up, we’ll build the building. And if not, I don’t really care about guidance. We try to give you the best guidance we can, but we don’t run our business according to guidance. We could be lower or we could be higher. I think we’re going to surprise people on the upside. But let’s wait and see. We don’t have to make that decision today.

Operator

Our next question comes from the line of Ronald Kamdem with Morgan Stanley.

Ronald Kamdem — Morgan Stanley — Analyst

Just going back to the lease signing of 84% during the quarter. It sort of suggests that the commenced leases should be accelerating as well. But how do I marry that with the full year same-store NOI guidance where you’re guiding for 8.625 for the year, but year-to-date it’s 8.7, so suggesting a little bit of deceleration? Just trying to understand what could be driving that? Is it occupancy of the comp versus the lease signing that’s accelerating?

Tim Arndt — Chief Financial Officer

Yes, Ron. Look, this is a good opportunity actually to distinguish the 2 metrics. So the commencements were 62%, and that’s why we’re actually calling out the 84% on signings because of the lag that sits between the two. The lease signings on what started this quarter generating the 62% were probably done in the first quarter. So all that means that the 84% we’re signing today, we’re really not going to see those commence until ’23 outside of the same-store period in our guidance. So that’s why we’re actually focusing on signings. You’ll probably hear a bit more of that going forward.

Operator

Our next question comes from the line of Camille Bonnel with Bank of America.

Camille Bonnel — Bank of America — Analyst

We’ve seen the spread between market rent growth and lease escalations widened over the past 2 years. Can you talk to what percent of your leases have a fixed structure? What are the escalators you’re achieving on new leases? And how sustainable these are throughout the duration of the lease?

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

Virtually all leases have escalators. I would guess the average is 3.5-ish, maybe approaching 4%. And yes, 4%, I’m getting a lot of 4s, thumbs up here. And what was —

Tim Arndt — Chief Financial Officer

I would just clarify that the installed base is probably the 3.5% you mentioned and then more recently 4%.

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

Yes. And I think that was it. Did you have a third part to your question?

Camille Bonnel — Bank of America — Analyst

Just wondering how sustainable these increases are throughout the duration of the lease.

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

Well, they’re contractually obligated to increase. So it’s not — and they’re contractual. They’re not CPI-driven or anything like that. So I guess unless the tenant goes broke, there is no risk to that.

Operator

Our next question comes from the line of John Kim with BMO Capital Markets.

John Kim — BMO Capital Markets — Analyst

I realize that the markets are very fluid, but I did want to ask about the 4.1% cap rate that you have stabilized on your development starts. I guess, industrial would be the 1 asset class that you could argue the most for negative leverage given the strong mark-to-market that you have, but new developments are signed basically at market. So it doesn’t have its same mark-to-market potential. So can you make the argument or couldn’t you make the argument that new development should be at a higher cap rate, which I know was counterintuitive to how it’s been recently, but it’s reflective of that market today?

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

Yes. By the way, I don’t think there is any negative leverage even today. Let’s just go to basic principles. The reason interest rates are going up is because we have inflation. Real estate in a tighter market equilibrium situation, so there’s pressure on real rents going up. If we continue in an inflationary environment where rates are up, we’re going to get more rental growth, not rental growth because vacancy rates are very low. So really, in terms of IRR, we have positive inflation — positive leverage. And that’s the way it has been for 30 years of my 42-year career. Positive leverage on IRR, not necessarily positive on the going in cap rate or cash yield compared to interest rates. That’s the way the business works. It’s total return dependent.

And total return in a high interest rate, high inflation environment is going to have a big growth component to it. Unless the market is 10%, 15% vacant, in which case, inflation doesn’t matter, you don’t have pricing power. But we expect to have pricing power for the foreseeable future even in a really, really conservative absorption scenario. And I went through that before. I can’t imagine a scenario anytime soon where vacancy rates would reach 5%. So I think we’ll have pricing power, and I think we have positive leverage on an IRR basis. And by the way, short-term rates have moved up a lot more than the long-term rates. And really, real estate is an infinite life asset. So you got to compare its returns to 10-year or more longer debt. Tim?

Tim Arndt — Chief Financial Officer

I just want to clarify, John, maybe you see this, but I want to be sure you note that we have in the supplemental, both the exit cap and estimate on it and the development yield, I think you’re quoting the exit cap. The development yields are 6%, 6.5% in the portfolio. So I want to be sure you understand that distinction.

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

Hence, the huge margins.

Operator

Our next question comes from the line of Jon Petersen with Jefferies.

Jon Petersen — Jefferies — Analyst

I was looking at the sort of the Promote opportunity next year for the targeted US logistics fund. I realize it’s volatile and there’s a ton of assumptions that go into this. So maybe you could help us and remind us what the hurdle rates are that you have to hit each year to be eligible for a Promote? Just kind of how that structure works, once you hit the hurdle, like what percent of the NOI you get, so we can all be dangerous and make our own assumptions. And then another question I have is on the land portfolio. I think you have it on the books at $2.7 billion. Any estimate on how we should think about the market value of that land portfolio today?

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

Yes. I think market value of land was double our book value. And my guess is, before this is all over, and not a single piece of land has not really traded in any scale so that I can give you an actual estimate, but I would guess land values before it’s all over will decline by 30%, which would put them still significantly above our book value. So that’s where we are. I think the Promote hurdles are 7, and it’s a 20% part — yes. And we have 2 hurdle promotes, actually 7 and 10 and 15 and 20 is the upside participation in those, and those are leveraged hurdle rates. So 15 over 7, 20 over a 10.

Operator

Our next question comes from the line of Anthony Powell with Barclays.

Anthony Powell — Barclays — Analyst

A question on acquisitions. Can you talk more about the CrossBay deal, what brought you to that transaction? I think you talked before about maybe more portfolio deals happening in Europe. Are there more news out there? And what’s your, I guess, willingness to do more deals on the balance sheet given kind of the overall macro environment?

Dan Letter — Global Head of Capital Deployment

This is Dan. I’ll take that question. So the CrossBay deal, closed last quarter, we, I think, first introduced that deal probably in February. We were able to — when we first talked about this deal, the bid-ask was pretty far apart. But we’re actually able to win that deal at a very favorable price. We actually got a couple of price reductions, and we really love the real estate. It’s very complementary to PELF, and the team is very excited about bringing that on. As it relates to other portfolios, the way I think about deploying capital right now, I think about really disciplined, I think, about patience and I think about opportunity. We’ve always run a very disciplined deployment machine. And our team, boots on the ground, are calibrated for that and are excited about it. We’re being patient right now because we do expect to see opportunities that come from — as a matter of fact, we’re making money today based on decisions that we made in the depths of the GFC. So really excited about what opportunities could come.

Operator

Our next question comes from the line of Michael Carroll with RBC Capital Markets.

Michael Carroll — RBC Capital Markets — Analyst

I wanted to touch on an earlier question to see if we can get a little bit more information regarding the larger users with more mature supply pipelines. I know you touched on a few examples. But in general, how big is this bucket of these larger users slowing down? I mean, is it mostly Amazon? And I believe you mentioned FedEx, there are like a few other outside of that or is that about it?

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

Everybody is running to catch up on their e-commerce supply chain because they’re starting behind and they need to catch up. So the demand for e-comm space is broadening. But remember, e-com is just maybe 20% of the overall demand. At the same time that, that’s going on, people are building resilience in their supply chain. So inventory levels have adjusted upwards like we predicted. We think half of that adjustment has already occurred, and there’s another half of it to go. So I think you’ll see all customers or virtually all customers building more resilience into their supply chain by taking up more space so that they don’t get caught with the wrong inventory in the wrong place at the wrong time. But demand is definitely broadening.

Mike, do you want to?

Michael S. Curless — Chief Customer Officer

Yes. And I think I could just give you a sense on all customers are being certainly more introspective and cautious these days. That’s natural in times of uncertainty. But if you look at our build-to-suit list, for example, it’s a narrower list. Amazon is currently pausing. But the customers that are on the list are still following through with long-term supply chain reconfigurations that have been in place for a long time, and they are following through with those with the same effort that we’ve seen before. So I would say if you look at build-to-suits, it’s a smaller, more active list of customers. And our competitive environment looks even better. There’s fewer private competitors out there that are direct competition given the current market conditions. So I view that business as smaller but a deeper prospect list with a higher win rate possibility. So that’s one perspective.

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

Yes, the point Mike just made about the competition on the private side is a really, really important one. I mean, these guys depend on leverage. Leverage is not available. It’s not just a question of the cost of it to a lot of these people. So we’ve already seen certainly layoffs in Europe with respect to some of the very aggressive private guys, and I think we’ll see some of that in the US, too. So again, another reason why we have a good balance sheet is to use it when the opportunities are there.

Operator

Our next question comes from the line of Michael Mueller with JPMorgan.

Michael Mueller — JPMorgan — Analyst

Is your 65% year-end lease mark-to-market expectation with or without Duke in it?

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

That’s with Duke.

Operator

Our next question comes from the line of Dave Rodgers with Baird.

Dave Rodgers — Baird — Analyst

Hamid, thanks for the details on tenant credit that you provided earlier. I wanted to go back, and maybe this is a draconian question, but when you go back to global financial crisis, I think PLD lost 600 basis points of occupancy top to bottom. Some of that might have been credit loss, but even though it’s not credit loss, then some tenants may leave just due to the same factors that we’re talking about. I guess, how does today differ? And I guess, I’m just a little worried about the convexity of noninvestment-grade now above 10%, those types of things. I guess how does your portfolio differ? How do you think the market differs? And then maybe a follow-up to Chris. Last quarter, you had suggested a 75 basis point increase in vacancy for ’23 for the market as a whole. Has that number changed?

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

Okay. I’m not sure I understood the second part. But the first part, first of all, I don’t know about Prologis, but I think there was 52 million square feet of spec space that they had built at that time. And the company at that time was, I don’t know, 400 million square feet or something. It was a huge part of the installed base, and most of it was spec. So you went into global financial crisis with a collapse in demand and you were starting off with a 7% or 8% vacancy rate even before going into the global financial crisis, so it was different at least in 3 respects. One, level of spec development; two, the starting level of vacancy; and three, the impact of that on a much, much smaller company than today. So very, very different situation. But the numbers for AMD were that we went from mid-95% occupancy to 91% occupancy.

And by the way, the exact same thing happened in the dot-com collapse, which was people had overcommitted to space. The difference is that the shadow space in this market is very low. That’s why we look track utilization. We have 90th percentile utilization in the buildings in terms of history. So occupancies are high, utilization is high, there’s a lot of ongoing demand and we’re starting off at the 98% occupancy. Even if the global financial crisis were going to repeat itself, we’ll be at 94% occupancy. That’s just fine. There’s no problem with that. We can get rent growth at those kinds of numbers. So I don’t even think of those draconian scenarios. Of course, somebody launches a nuclear war somewhere, all bets are off, but I’m not capable of making those.

Christopher N. Caton — Senior Vice President & Global Head of Research

Dave, as it relates to the forecast we shared you remember correctly but got the units wrong. So we had said we could see a supply demand gap of 50 million to 100 million square feet next year, which would only be 30 basis points of occupancy increase. Our latest view probably has it at the higher end of that range, say, 100 million square foot gap, which would lead to a high 3s or a 4% market vacancy, which again is below the low that prevailed during the decade before. And then also call out in Tim’s script that based on the capital market landscape, we could have a gap in development starts that would ultimately translate to a gap in deliveries late next year and early ’24.

Operator

Our next question comes from the line of Bill Crow with Raymond James.

Bill Crow — Raymond James — Analyst

Two questions. First of all, any change in the lease-up time on new deliveries? And the second question is, you talked a lot about cap rates and cap rate increases over the last 6 or 7 months. I’m just wondering if you were to underwrite an acquisition today, how would that change to from where you were early this year? Let’s say, how much how much do you think cap rates have gapped out on a like-for-like deal?

Tim Arndt — Chief Financial Officer

I can start on the lease-up times, and I think Hamid made reference to this just that compared to underwriting. We’ve consistently beat underwriting, and that would remain the case today. Maybe there’s a month lower there, but we’re continuing to beat underwriting in new development leasing.

Michael S. Curless — Chief Customer Officer

I would say on the cap rate side, you see it in our development portfolio in the supplemental. We moved our exit cap rates from 4.1 to 4.7. So that’s demonstrative of the change that we’re looking at across the board going forward.

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

So if you — I would say, for the last couple of years, we’re looking at about a 6% unleveraged IRR in acquisitions, using about an average of a 3% growth rate on rents and that gap is 300 basis points. By the way, that’s the most important number that you look at, that I look at anyway, and replacement costs. So if you believe inflation is going to be higher at 4%, rents will grow at least the kind of inflation given what’s happening to replacement costs and given the tightness of the market. So you could expect with the 4% growth rate that the IRRs would be 7%, 7.5% going forward. So the point I’m trying to make is that you just can’t look at discount rate of those cash flows without considering the growth rate of those cash flows. And those 2 don’t move perfectly in tandem, but generally move in line with one another in a market that has a vacancy rate below equilibrium.

Operator

Our final question will come from the line of Jamie Feldman with Wells Fargo.

Jamie Feldman — Wells Fargo — Analyst

We were just thinking about how should we think about FX and how that goes into your calculus when you’re thinking about investment activity given how strong the US dollar is and your unique global platform? And then secondly, if you could just give us some thoughts on when you think the mark-to-market stops expanding. I think it’s been surprising to us how it just keeps going quarter-after-quarter. I’d love to get some thoughts on when that might moderate.

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

Yes. So FX are — I’ll give you the big picture theory, and Tim can give you the details. We do 3 levels of FX management. Number one, we want to have a global platform to serve global customers, but we do not want to have our capital equally in every place because we’re a US dollar dividend payer. Therefore, we use a higher percentage of private capital in our foreign jurisdictions than we do in US jurisdictions. So that’s the first step that we take. Secondly, we have a disproportionately higher amount of debt in foreign currencies matched against our equity or our share of the equity in those assets so that we are neutralized in terms of asset and liability movements with respect to the movement of interest rates. In other words, $100 of equity and $100 of debt against it.

By the way, the US is much less leveraged. So our overall leverage is very good. So that’s the second level that we manage the asset value, which is really the big dangerous thing in real estate. So on those, we’re perfectly hedged. Perfectly hedged. Not overhedged, not under hedged. Perfectly hedged. Then there is the issue of how do you manage earnings, FX on earnings, which is more of a flow management, and that is by buying hedges that go out and protect earnings for 2-ish kind of years.

Tim Arndt — Chief Financial Officer

Yes. And I would say even longer, we ladder into that strategy where the next few years are quite fully hedged, but we have hedges out to ’26, ’27 and the dollar cost average into it. I also think, Jamie, it sounded like underneath your question is how do we feel about sending dollars to Europe or to Japan. And frankly, that’s not really how it works. In these other jurisdictions, we’re typically recycling capital. That’s when we’re running the contribution model. Even at a time like this when the contributions at least in Europe are at a pause, we’re funding that with debt in-country. So we don’t really have the kind of issue, as I think you’re trying to highlight there.

Your second question was on the lease mark-to-market, I think, and how does it fall down over time. And I know you appreciate that’s going to be purely a function of what is market rent growth from here. If there are no market rent growth, it will come down more precipitously. And if there’s a reasonable level, say, high single digits, that’s probably going to be paired with our same store growth. And that would say the lease mark-to-market is going to be pretty constant for a while. So you have to make a bet on market rent growth to really answer that question, and we’re not doing that today over the long-term, but it’s got a very long tail to it, I think, is our view.

Hamid R. Moghadam — Co-Founder, Chief Executive Officer & Chairman

By the way, I would also say that the FX rates being so favorable to the dollar, there will become a time where there will be compelling opportunities to deploy capital in Europe because you could catch the combination of good values in local currency and a great exchange rate. So we’re not — we don’t expect to do that tomorrow or anything, but that’s another consideration that we always keep in mind, which is the opportunistic side of all these changes that we’re witnessing.

Before I let you go, however, I’d like to take a minute to highlight our Groundbreakers Conference, which happens next Tuesday at Hudson Yards in New York. It will also be streaming online. This is an annual thought leadership event, which will feature some of the most innovative voices in logistics today, including Dave Clark, formerly CEO of Worldwide Consumer at Amazon and now the new CEO of Flexport, which is actually one of our portfolio companies, plus a host of others that you won’t want to miss. We’ll dig into all the questions that you’ve been asking about in terms of macro trends. And I think it will be a very different event than yet another recumbence or something of that kind. So if you’re really interested about logistics and when it’s moving in the next couple of decades, these are the people that we brought together. So I look forward to seeing many of you there. We’ve had a tremendous response. And I think you’ll get a lot out of it. So please come. Take care.

Operator

[Operator Closing Remarks]