Welcome to the Prologis Q3 earnings conference call. My name is Michelle, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. At that time, please limit yourself to one question. If you have a follow-up, please get back in the queue. Note that this conference is being recorded. I would now like to turn the call over to Tracy Ward. Tracy, you may begin.
Thank you, Michelle. Good morning, everyone. Welcome to Prologis' third quarter earnings call. If you have not yet downloaded the press release, it's available on our website at prologis.com under Investor Relations. This morning, you'll hear from Tom Olinger, our Chief Financial Officer, and also joining us for the call is Hamid Moghadam, Gary Anderson, Chris Caton, Mike Curless, Ed Nekritz, Colleen McKeown, and Gene Reilly. Before we begin our prepared remarks, I'd like to state that this conference call will contain forward-looking statements under federal security laws. These statements are based on current expectations, estimates, and projections about the market and the industry in which the company operates, as well as the beliefs and assumptions of management. Both of these factors are referred to in Prologis' 10-K or SEC filings.
Additional factors that could cause actual results to differ materially include, but are not limited to, the expected timing and likelihood of the completion of the transaction with IPT, including their ability to obtain the requisite approval of their stockholders and the risks that conditions to the closing of the transaction may not be satisfied. Forward-looking statements are not guarantees of performance, and actual operating results may differ. Finally, this call will contain financial measures such as FFO, EBITDA, that are non-GAAP measures, and in accordance with Reg G, we have provided a reconciliation to those measures in our earnings package. With that, I'll turn the call over to Tom, and Tom, will you please begin?
Thanks, Tracy. Good morning, everyone, and thank you for joining our call today. We had another outstanding quarter. Customer sentiment remains positive, and we see no meaningful impact on our business from uncertainties surrounding trade. Our proprietary operating metrics reflect healthy demand, showing deal gestation conversion rates are positive and in line with last quarter as our customers improve their supply chains in response to consumer demand for ever-faster delivery times. U.S. market fundamentals are strong. I'd like to share our assessment of third-quarter market statistics, as we've seen more divergent viewpoints than normal. We've seen historically low vacancy in the mid-fours with supply and demand balanced at 75 million square feet each. Rents have outperformed, and as a result, we are raising our 2019 U.S. rent growth forecast from 6% to 7%, leading to an 80-basis point increase in our global rent forecast to 6.5%.
Activity across Europe remains healthy. In the U.K., while overall demand is solid and our build-to-suit pipeline is very active, we are highlighting the Midlands as a supply risk. We continue to forecast 2019 rent growth on the continent to be the highest in more than a decade. Fundamentals in Japan are improving, with vacancy in Tokyo at less than 3% and Osaka at less than 6%, the lowest points in five years. From an operating standpoint, you will see that our quarterly results reflect our strategy of prioritizing rents over occupancy to maximize long-term lease economics. We leased 38 million sq ft, including nearly 6 million sq ft in our development portfolio. Quarter-end occupancy was 96.5%, down 30 basis points sequentially and remains above our five-year average. Rent change on roll for the quarter hit an all-time high of 37%, led by the U.S. at 41.7%.
Our share of cash same-store NOI growth was 4.3% for the quarter, which was impacted by a 60-basis point reduction in average occupancy. Consistent with our strategy to push rents. Globally, our in-place-to-market rent spread widened by 40 basis points in the quarter and is now almost 15.5%, or over $400 million in nominal terms. Core FFO was $0.97 per share for the third quarter, which included $0.18 of net promote income from our PELP venture. The promote came in above our forecast as EUR valuations increased more than 2% in the third quarter. For deployment, starts in the quarter were $577 million with an estimated margin of 22% and included about two-thirds build-to-suit. The pace of starts will increase significantly in the fourth quarter. Stabilizations were $658 million with an estimated margin of 37% and value creation of over $242 million.
We continue to access capital globally at very attractive terms. During the quarter, we issued $2.8 billion of debt, primarily in euro, at a weighted average fixed interest rate of under 1% and a weighted average term of more than 14 years. It's worth pointing out that we have an annual need for an incremental $600 million of non-dollar debt to naturally hedge our growing international assets. These issuances lowered our total weighted average interest rate by 10 basis points to 2.4% and lengthened our weighted average maturity by about two years to just under eight years. We continue to maintain significant investment capacity on the balance sheet with $11.7 billion of liquidity and potential fund sell downs. In addition, there's an incremental $5.4 billion of existing third-party investment capacity in our ventures today.
Guidance for 2020, which I know many of you are looking for, will be provided at our upcoming investor forum on November 5th. For 2019 guidance, I'll cover the highlights and on our share basis, and note this guidance does not include the positive impact of the IPT acquisition. We're increasing the bottom end of our cash same-store NOI guidance by 25 basis points and now expect a range of 4.75%-5%. We are raising the midpoint for development starts by $250 million and now expect starts to range between $2.2 billion-$2.5 billion. Build-to-suits will comprise more than 40% of total starts, which is above our initial expectations. We are projecting $650 million of net deployment uses, which we plan to fund with free cash flow and debt.
Net promote income for the full year is now expected to be $0.18 per share, an increase of $0.02 from our prior guidance. For the full year, we're increasing our 2019 Core FFO guidance midpoint by $0.03 and narrowing the range to between $3.30 and $3.32 per share. At our revised midpoint, growth in Core FFO per share excluding promotes is 10% higher than last year. Over the past five years, our growth has clearly been exceptional, with a CAGR of almost 12%, while de-levering from 27% to 18%. As I mentioned, this guidance excludes the acquisition of IPT, which we expect to close in January of 2020. We plan to split the $4 billion portfolio equally between our two U.S. vehicles. Private capital investor interest continues to be robust, as evidenced by the record fundraising in our ventures in the third quarter.
Our pro-rata investment will be approximately $1.3 billion, which we will fund with cash and debt. We continue to expect the annual Core FFO accretion from IPT to range between $0.05 and $0.06 per share, or roughly 2% on a stabilized basis. The acquisition of this high-quality portfolio will capture significant revenue and cost synergies and deliver shareholder value on day one. To sum up, the third quarter was a continuation of what has already been an excellent year. I feel great about our outlook for the rest of the year and beyond. With that, I'll turn it to Michelle for your questions.
At this time, if anybody would like us to ask a question, please press star one on your telephone keypad. Again, that would be star one on your telephone keypad. Thank you. Your first question comes from Craig Mailman from KeyBanc Capital Markets. Your line is open.
Hey, guys. Just want to hit here on demand and kind of where you guys have the availability in the portfolio. Could you guys just kind of talk through what you're seeing in the demand profiles between kind of larger and smaller tenants and your ability to push rents there and maybe improve credit quality? Kind of talk a little bit about what you guys see as your ability to push the occupancy in under 100,000 or under 250,000 square foot space where you have more opportunity and maybe talk, is there any more frictional vacancy in those type of spaces than in your bigger box? Could we see those kind of spaces kind of narrow to where your average occupancy could be?
That's some question.
I know.
Did everybody write down? Everybody write down. Well, let me take a stab at this first, maybe talking about the smaller spaces. These are spaces where we can push rents, and we're seeing pretty broad-based demand, frankly, across all sectors. I think those are the smaller segment is where we can push rent growth. I think if you look inside our rent change numbers, which are obviously at all-time highs, that would be the highest. In terms of the composition of demand from an industry perspective, again, that's pretty broad-based. Obviously, auto is weak almost no matter where you are on the globe. Otherwise, we're still seeing pretty broad-based growth. We're seeing continued growth from the e-commerce sector, and that's probably a combination of reconfiguration of the supply chain as well as net demand. That's a start on it. Craig, this is Tom.
Two of your questions, one on credit quality. Our credit quality continues to be exceptional. Our bad debt experience has been below 20% or 20 basis points of rent, below 20 basis points of rent for the last six years, continues this quarter. I feel great about our credit quality. Then just regarding your question on small spaces and frictional vacancy, we do have many more units in our smaller spaces. Naturally, there's going to be more churn in that, particularly as Gene pointed out, we are pushing rents. You could see a little higher frictional vacancy, but the payoff is much higher rents. The economics are clear to keep pushing rents.
Your next question will come from Jeremy Metz from BMO. Your line is open.
Hey, good morning. Hamid, FedEx on its earnings call last month, they were citing more challenges ahead in 2020. They talked about the global trade disputes and concerns over economic slowing having created significant uncertainties. In your opening remarks, Tom did mention that you hadn't started to see that in your customer behavior yet. Clearly those risks are out there. Just wondering, has that surprised you at all that you really haven't seen it in the customer behavior yet? Then maybe just any broader thoughts on how this all impacts your outlook for development starts beyond the call it $2.3 billion you have underway in terms of cadence or desire to take on spec, et cetera? Thanks.
Sure. I think both statements can be true at the same time. FedEx cares more about flows. Obviously those become very volatile when it's trade wars one day and no trade wars the next day. They have a very fixed cost basis infrastructure, planes and trucks and all that. Erratic volume cannot be good for them because they either miss the peaks or can't handle the peaks or have too much capacity for the troughs. We're in the stock business. Actually, uncertainty in the short term is extra demand for our space because when you don't know when that next good is going to get to you because of tariffs or at what cost, you're going to carry more inventory and more stock closer to the customers.
I think FedEx is right as far as the metrics for their business are concerned, and I think the metrics for our business are just different.
Your next question will come from Derek Johnston from Deutsche Bank. Your line is open.
Thank you. Hi, everyone. Can you discuss the leasing process for the multi-story facility in Seattle where Amazon and Target ultimately signed? How competitive was this bidding process? How many interested parties did you have, and where did rents shake out versus underwriting? What type of future demand do you anticipate? Thank you.
I would say the rents and the economics turned out better than our expectations. It took a little bit longer to lease up, but it leased up at higher rents. The reason it took a bit longer to lease up is that nobody's ever seen a multi-story building before, so they wanted to look at it, lay out a lot of different configurations, and make sure they could get the efficiencies out of it. We couldn't be more pleased with the quality of the tenants or the financial performance of the asset. With respect to its implications, look, for some reason, this building has gotten a lot of attention, and people think that there is a multi-story strategy. There is no multi-story strategy. The strategy is to provide space at places where our customers want them, which is increasingly close to their ultimate customers.
The solution in some places is multi-story, and in other places is single story. We're not in the business of building so many multi-story buildings. We're in the business of growing our infill position.
Your next question will come from Vikram Malhotra from Morgan Stanley. Your line is open.
Thanks for taking the question. Blackstone just sold a part of their original GLP acquisition. Wondering if you looked at that portfolio, and if you can just more broadly give us any sense of any portfolios across regions in sort of how pricing or cap rates are shaking out.
Vikram, you can assume that we look at everything. People know our phone number, and they know what business we're in. We absolutely, positively have never thought of it, a material transaction that we haven't seen. You can assume we look at everything. I think the implications are, you're going to have to ask Blackstone, but obviously they bought that portfolio, and presumably, they paid a pretty good price to get it. Presumably, they sold it to these guys who must have presumably paid a really good price to get it that was attractive enough for Blackstone to sell it. I can't be any more specific than that because I'm not in Blackstone's decision-making rooms. Those assumptions would be probably pretty fair.
Your next question comes from Jamie Feldman, Bank of America Merrill Lynch. Your line is open.
Thank you. I want to get more of your thoughts on just the supply outlook. We do have historically high supply coming online, but you just said your development starts were 63% pre-leased in the quarter and you want to start more. You expect to pick up in the fourth quarter. Can you kind of paint the big picture of how we should be thinking about the supply risk heading into 2020? As you think about your new development opportunities, the pre-lease percentage, and what gives you comfort at this level of volume?
Hey, Jamie, hear me here. I think there's a lot of confusion about supply numbers. People mix supply, which is an annual concept, with what's under construction, which is a snapshot at a given point in time. Let me have Chris take you through those numbers because they're materially different as construction duration has lengthened.
Yeah, absolutely. Jamie, let's talk about three concepts. First, completion. Completion is actually on pace to be down this year by about 8%. When we look at a more real-time indicator like starts are flat this year. Now, as Hamid mentioned, duration to build projects has gone up, and so we've seen under construction rise. That time to deliver products has gone up by about a third in this cycle for all the challenges around supply that we've previously discussed. Deliveries out of that pipeline now are much less than 100% in a given following four quarters. You got to look at the time to deliver product to understand what deliveries will be in the following four quarters.
Basically, if you had the same level of supply, the same level of property under construction, you would have two-thirds the annual supply if the trends of the recent past continue. Those two concepts need to be really kept apart.
The next question comes from Blaine Heck from Wells Fargo. Your line is open.
Thanks. Hamid, in the press release, you pointed out the exceptional interest that you're seeing for your strategic capital ventures, and you guys have obviously done a great job raising money on that side of the business. Can you just talk about whether there are any specific groups that you're seeing incremental interest from? On the flip side, what do you think could cause that investor interest to decrease? I guess, is there anything that kind of sticks out to you as a threat to that capital source in particular?
Yeah. The sources are pretty much from everywhere. I would say the U.S. pension funds are probably flat to down compared to their, call it 10-year type numbers. Japan is up significantly. Generally, Asia is up significantly as these large institutions and sort of the pension system gets active on alternative investments. It's everywhere. On the margin, I would say U.S. a little less and Asia a little bit more. With respect to the threats to that, it's the same old threat that we've seen in every cycle. It's the denominator effect. If these guys are generally at today's investment levels, under-allocated to real estate, and alternatives generally, and really under-allocated to industrial because it's a tough property type to access.
If the stock market goes down and the bond market goes down and the rest of the portfolio goes down, the same percentage allocation to real estate will have to go down, and that's usually been the cause of reductions in capital flows. Did I answer that?
The next question is from Ki Bin Kim from SunTrust. Your line is open.
Thanks. Good morning out there. Just two questions. Hamid, what's your view on the potential impact from grocery e-commerce on the warehouse business, and how PLD would potentially play a part? Second, just on lease spreads, obviously some really good numbers. Anything interesting about the mix of what rolled this quarter that might be different going forward?
Yeah. I'd let Tom answer the second part. I think there are three things that drive the share of e-commerce in our portfolio or the space devoted to it. Number one is penetration, increasing penetration of e-commerce as a percentage of total sales, retail sales. That number has gone up every year. I think will go up for the foreseeable future as more categories become e-commerce friendly and as the millennials, I guess they're not millennials, the Generation Z who grew up with an iPhone, start entering their prime shopping years. The iPhone, I think is 11 years old, and 12-year-olds who are now graduating from college, or 11-year-olds who are graduating from college, basically have never known a world without an iPhone and e-commerce. I think as those guys enter the spending part of the population, I think the percentage will go up.
There's the old 3x factor of space that e-commerce takes, which, well, on top of the gain share of e-commerce and underlying retail growth, which is probably the slowest of the three factors, maybe 2% type of thing. All those three factors combined should make for a really good environment for e-commerce demand over time. Now, the real strategic question is, how does automation affect this 3x factor? Does it reduce it? Does it expand it? The answer on that is unclear at the moment. In certain instances, it increases the need for real estate, and in certain cases, it reduces the need for real estate. One area that for sure over time will get more efficient is the returns business. Returns are really caused by free shipping and free returns and all that sort of thing.
Over time, I think fit and issues like that will get better. I would guess that part of the demand in warehouse space will go down. The biggest strategic driver of all this, long-term secular driver of all this, is the need for speed and choice. The more choices you want and the quicker you want them, the more inventory you need to position near the customer. That's all really good for our business.
Ki Bin, this is Tom, on your question about rent change for the quarter. We did see a higher mix this quarter in the west and east regions, so the coastal markets of the U.S. That being said, almost every region had its all-time high or near its all-time high in rent change. We're seeing very positive rent change across the board, almost without exception. You ask about a trend. Our four-quarter trailing average rent change is right at 28%. This quarter, I think that's a pretty good outlook in the near term for where rent change should be. Remember, when we talk about in-place to market at being 15.5% below market, that means rents need to grow 18.3% to get to market, right? If you're 15.5% under rented, you need to grow by 18.3%, that's just math, to get to market rents.
Think about our in-place.
Built-in rent change at being 18.3%. Think about what's rolling near term is obviously signed further ago. Naturally, our rent change would be higher in the near term. The last thing I'd point out is rent change. The rent change on all that four-quarter average, we're now at 28%. That's up 600 basis points in the last year. We've seen that number move up meaningfully, and I think we can hang around there based on our in-place to market.
Your next question comes from Eric Frankel from Green Street Advisors. Your line is open.
Thank you. Just two quick questions. One's related to portfolio sales, just based on the affirmation of Blackstone activity. Do you see any meaningful differences between portfolio sale pricing versus smaller transactions you guys might pursue? Second, just on the demand front, obviously, there's a lot of press given to smaller buildings and multi-tenant leasing. My conclusion is that that kind of leasing and the rent growth you can get is really more dependent on location than property size. Can you affirm whether that's true or not, or is a smaller building in some Midwest market getting record rent growth as well? Thank you.
Eric, let me jump in the middle of that before Gene starts on the first part. The most important thing with respect to rent growth is location in terms of macro market and the micro sub-market. By far, more important than tenant size and all the stuff we talked about before. You're spot on that one, and those are the scarce properties. Gene, do you want to answer?
Yeah. Eric, with respect to the portfolios, as Hamid mentioned, of course, we look at all these things, we price them. For sure, lately, portfolios are selling at what we consider a premium to the sum of the parts. I think that is true. Having said that, there's also plenty of one-off transactions in very good markets that have pretty stunning metrics associated with them.
Your next question comes from Caitlin Burrows from Goldman Sachs. Your line is open.
Hi there. I was just wondering maybe on the development side. The total development portfolio declined slightly since last quarter, but the 2019 starts are actually up. Is this just a function of pulling forward previously expected activity, and what's your confidence in being able to sustain that level of starts going forward as Prologis grows? Just on the yield side, those have come in a little, I think, from about 6.5%-6.1%. What's driving this, and could that increase back up?
On the second point, that's really basically mix.
Okay.
Having said that, you have generally seen cap rates declining, frankly, over the last, well, for 20 years. Over the last couple of years, cap rates have been declining, and you will see some change in the returns on costs as well. In terms of the development volumes, what we're implying is a big fourth quarter, about $1.2 billion, but I think that's about right on top of what we did in the fourth quarter of last year. We're highly confident of that, and in terms of the future beyond that, we'll talk about that when we give guidance for the future.
This reminds me of a previous question that Tom didn't answer, which is what's our attitude towards spec development? I would say the bar on spec development has been high and continues to be pretty high, and you can see the results of that in the build-to-suit percentage being a lot higher.
Your next question comes from Manny Korchman from Citi. Your line is open.
Hey. Good morning, everyone. Tom, just thinking about your year-end occupancy guidance. Your retention in the quarter was actually higher than the trailing few, and yet you commented in the press release that you're focusing on rent growth versus occupancy. Does that mean that new leases aren't happening as fast as you thought? Is that because of rent levels, or is there something else that's sort of not connecting between retention rates and occupancy?
This is not Tom, but I'll answer your question. The retention ratio, you're dealing with tenants that are already in the space, and today labor is a huge issue for people. Every time they move, they have to go hire a bunch of people because now the workers have choice, and they're not going to change their commuting patterns, et cetera. Customers that are in existing space have a much higher propensity to stay regardless of almost rent, which is an afterthought for a lot of them. Where you see the effect, the primary effect of pushing rent is on capture of new leasing in the developments. That's where you're likely to see it the most, and that, of course, doesn't affect the retention numbers that we report.
The next question will come from Nicholas Yulico from Scotiabank. Your line is open.
Thanks. I just had a question on the leasing spreads. I know you kind of gave some info on what drove it higher this quarter. I just want to make sure as well, though, that the switch to the Clear Lease in the past year, has that had any impact on the way you guys measure the re-leasing spread?
No impact at all.
The next question will come from Michael Carroll from RBC Capital Markets. Your line is open.
Yeah, I just want to follow up on the, I guess, PLD stance on pushing rents over occupancy. Hasn't this been your stance over the past few years? Are you just being more aggressive today? Is that a good fair way to say is what's being reflected in the lease spreads and how they're pretty much doubled in what they were for the trailing four quarters?
It's been our stated objective to do this for previous quarters. There are these messy things called human beings and people in the field that need to change their mindset, and that took a couple of years to really get that going. We track why we lose tenants when we don't renew somebody. We've tracked them for a long, long time. I'm not kidding you. There were years that we had literally zero tenants leaving because of rent on renewals. Literally. That number is no longer zero. It's a lot lower than I think it should be, or I would've expected it to be.
Your next question comes from Steve Sakwa from Evercore. Your line is open.
Thanks. I mean, I just wanted to clarify when you and Chris talked about sort of the construction pipeline or time to build getting longer. Is that nine months to 12 months or is that more of a 12-month to now 16 months? Just trying to understand that. Are there any markets in the U.S., you didn't really call anything out, but just trying to get a sense. Are there markets in the U.S. that you're a bit more worried about or really just seeing much less rent growth today?
Yeah. Just by the way, on the duration of construction, it depends on where. In Japan, they were 16 months, and I don't know what they are today, but takes longer to build a multi-story building. Let's focus just on a single-story, U.S.-style warehouse, and Chris has the numbers for you.
Hey, Steve. It's going from eight to nine months to something more than a year. Call it 13, 14 months. What I think we will see is that deliveries over the next four quarters can be roughly 75% of the under-construction pipeline. That's how we see the numbers coming together. As it relates to markets, we talked about on the last call how we haven't added any markets to our supply risk list. That remains the case today. In fact, a market like Chicago comes off that list this quarter.
Yeah, Osaka came off a little bit earlier.
Yeah. Osaka is the market that came off. On that list include Atlanta, Pennsylvania, Houston, Spain, and the Midlands was covered in Tom's script.
I would say the one that I would point out as being more at risk today than last quarter, even though it was on the list, is Houston. There is a lot of space under construction in Houston. I think some people are going to get surprised. Some of it is not in the best sub-market. Some of the outlying sub-markets in Houston you need to watch. Fortunately, we're not exposed to those sub-markets.
The next question will come from John Guinee from Stifel. Your line is open.
Great. I think Mike Curless is in the room. I was just looking at page 24, and I noticed an uptick in a pretty sizable land acquisition year to date and also acquisitions in other investments in real estate. Can you walk through, Mike, where you're buying the dirt and also what the other investments in real estate might be?
Probably Gene should answer that question since Mike has a new job. Gene, go ahead.
Yeah. Mike can maybe offer a customer color. We're being with the dirt. John, where we generally need to replace dirt is in the coastal markets where we've done a lot of development, absorbed a lot of the land bank. There's a piece in L.A. included in that. As we look out going forward, replacing land is very, very expensive these days. As you know, we've done a lot of work to work this land bank down to what we considered a manageable level. As we replace land going forward, we're trying to do it creatively. We're trying to tie up land through options. It's going to be more expensive and we'll see the land bank pick up a little bit, but we're going to remain very disciplined on that front as we have been.
Our biggest needs for land, I would say, are Southern California. We're good in Seattle, we're good in the Bay Area. Southern California, we need more land. Chicago, we need more land. I would say New Jersey, we need more land for sure. Those are the top three that I would call out.
With respect to the customers and where they want to be, two, three years ago, 80% of our land that we do in build-to-suits and we're in global markets. Those numbers are closer to 95% these days.
John, your question about the other investments, just think about those as being covered land plays.
Not land, but will become land soon.
Yeah. Those are actually yielding probably pretty close to the local market cap rate, maybe a tad below, maybe 20, 25 basis for land plays.
The next question comes from Michael Mueller from J.P. Morgan. Your line is open.
Yeah. Hi. I was wondering, do you expect the elevated mix of build-to-suits to be a little bit more of the norm over the next year or so?
This is Mike Curless. Yeah, we did have a robust quarter at almost two-thirds build-to-suits. If you look across the year at blending in the high 30s, then I'd expect our numbers to be in the low 40s as we look forward. I think this was an unusually high quarter, but directionally indicative of how important the build-to-suit part of the business is to us these days.
Compared to five or 10 years ago or 15 years ago, that number would've been 20, 25%. I think the tightness of the markets is forcing the build-to-suit percentage up.
Your next question will come from Craig Mailman from KeyBanc Capital Markets. Your line is open.
Hey, guys. Just want to hit on your liquidity here and the funds and on balance sheet. Your cost of capital is clearly advantageous, but you have a lot of well-heeled competitors as well. I'm just curious, you guys look at the acquisition landscape. You've been successful in some, missed some others. Just how you look at return requirements for on-balance sheet acquisitions here versus the in-funds, and just talk a little about what you're seeing on the quality spectrum of portfolios that have traded or may be out there and kind of interest level.
Let me start that. Gene, jump in if you'd like. I think the pricing for quality differences is getting compressed. In other words, cap rates for lower quality, lower growth assets are compressing against high-quality assets on location. That always happens in this part of the cycle. People are really anxious to get into this asset class. If it's industrial, it's industrial, and they become less discriminating over time. If you're a leveraged buyer, and you're really looking at locking in the cost of debt capital today, and you employ a lot of it, obviously this is a really good environment for your buying things and financing them.
With respect to the way we look at our unleveraged WACC or our cost of capital, I would say we look at that every quarter or so. We occasionally, and only in a very limited way, have dropped our requirements. I would say for a U.S. high-quality portfolio, probably a six IRR would be the right number today. Very high-quality portfolio for us. Take it up from there. Unfortunately, some stuff in the marketplace, even for low-quality assets, is getting priced tighter than that. Now, a six IRR in a 1.6% or 7% 10-year environment is pretty attractive. Those are some of the widest spreads I've seen in my career. Yeah, the absolute numbers sound low, but in relation to cost of capital or net cost of capital, they're actually pretty attractive.
Your next question comes from Vikram Malhotra from Morgan Stanley. Your line is open.
Thanks. Just wanted to follow up on two things. One for Chris. You mentioned some of the rent growth, and obviously it's different by sub-markets. I'm wondering if you're starting to see any divergence from recent trends in sub-markets within MSAs, meaning more divergence than what you've seen recently. Just one for Tom on the Clear Lease. Wondering if any impact on the expense side, and if it may be positively or negatively impacting NOI growth?
As it relates to rent growth, a couple ways to look at that. One is we continue to see that divergence between infill and non-infill, as Hamid was discussing earlier in terms of sub-market strategy. As it relates to markets, we've seen better outperformance in the East, in New York and in Toronto, for example, and we continue to see really good growth in Europe, much like we telegraphed last year and the year before. What you see there is some of the early recovery markets continuing to outperform, whether that's Germany or the Netherlands or Czech Republic, and some late recovery markets really starting to pop. France comes to mind. That's how the rents are trending.
Great. Vikram, on your question around the Clear Lease and expenses. Those leases are set up where we fix all the costs but real estate taxes, the tenant bears that, and we are collecting slightly more on the expense reimbursements right now. Essentially call it even. We set it up that way to be expense neutral, so no impact on NOI. To go back to Nick's question just on the Clear Leasing, did that have any impact on how we're calculating rent change? It does not. That Clear Lease, just think about it simply having a rent component and an expense reimbursement component, and the rent change is calculated on the revenue, the rent component, not the expense component. No impact.
Yeah, I just want to clarify something, Tom. We actually don't collect reimbursements. That's why it's a Clear Lease. We do track what it would've been under a triple net lease. Actually, for the last year and a half or two that we've been implementing this, the numbers have been remarkably on top of one another, and that's the advantage of having, I don't know, an 800 million square foot portfolio to spread this stuff around.
Your next question will come from Manny Korchman from Citi. Your line is open.
Hey. Hamid, I had a follow-up on my previous question, then I have a new one for you guys. You mentioned leasing the development. I guess that wouldn't impact your occupancy guidance. Just going back to that, in isolation, if retention is where you expect it to be, at 81%, and you've lowered your occupancy guidance, that means that your pace of lease-up in already vacated space or space to be vacated is going to be slower. Is that the wrong read-through?
Remember the part that I said that in the years we had zero people that we were losing as part of a renewal discussion? That number is not zero, it's not as high as I would like it to be. You're also talking about occupancy declines from 98%, I've been doing this for 37 years. There was only one year where we were in the 98% range, I said, "Guys, don't get used to this. We're going to push this number down." I think we're very clear on what our strategy was, I would say we've executed it exactly the way we described it.
Your next question comes from Jamie Feldman from Bank of America Merrill Lynch, your line is open.
Thanks. I was just hoping you could explain more why developments are taking so much longer to deliver? Also, just thinking about the TI number in the quarter and what we've seen this year, are you spending more on TIs on leases? If so, can you explain why that's happening and what that's going to, and is that impacting your ability to push rents as well?
Jamie, I'll take the first one. It's Gene. It's basically a combination of construction timeframe, and there's some entitlement timeframe in that as well, which by the way, can affect the project through its construction and as you pull secondary permits as you go forward. It's really those two items. Of course, depending on where you are geographically, there's a pretty wide range of outcomes.
We've also had kind of weird weather patterns that I think most of you have noticed. That definitely messes with construction schedules.
Jamie, on your second question on the turnover costs, it's a little higher this quarter. I think it's due to two things. It's mix and timing. I'd go back and look at what we've done on a trailing four-quarter. I think that's a better representation. We have been coming down pretty clearly on a trailing four-quarter basis over the last really three years, and that makes sense just given concessions are falling across the board. The other thing I'd point to is look at free rent as a % of lease value. That is consistently declining again. I think overall, this quarter's a mix and a little bit of timing. We're not trying to buy rent change, if that's the question.
Your next question comes from Steve Sakwa from Evercore. Your line is open.
Thanks. Hamid, I was just wondering if you could provide an update on sort of the big data initiatives and the procurement and sort of where you stand, and is that something we're likely to get a lot more detail on for 2020?
On the big data, we are, as I mentioned to you, tackling one very specific project, which is yield management. I would say that's going really well. We're piloting in four markets, and we'll be expanding that to the portfolio, and we're encouraged by the early results. I don't know, Chris may have more to say about that. Gary, you want to talk about the other initiatives?
On the procurement initiatives, we stood up that procurement organizations we talked about in the past, and things are going well there, I'd say, both in terms of procuring construction-related items and CapEx and G&A, so that is off and running. With respect to the revenue side of the equation, I'd say that we're off to a good start. We're starting to build that business. We're probably getting into the tens of millions of dollars in terms of revenue. It is becoming more meaningful, and we're seeing roughly double-digit growth.
Yeah, I would say that that business today, if you isolated it, would be pennies a share of incremental earnings. I think in two to three years it will be dimes, and we're hoping that its potential is more than a dollar. That is going to take us a while to get to. Don't put in the dollar. Don't put in a couple pennies that we're talking about right now. We're doing better than that, actually. It's a slow ramp. Nobody's done this before, so we need to educate ourselves and our customers and a lot of other people to get this done. I think, Steve, you were the last person.
Thank you all for your interest in the company, and I want to put in a big plug for our Analyst Day, which is coming up, and that's why we've saved all the good guidance stuff for that day to encourage you to come. Take care.
Thank you, everyone. This will conclude today's conference call. You may now disconnect.