Q2 2024 Prologis Inc Earnings Call
Participants
Justin Meng; Head of Investor Relations; Prologis Inc
Timothy Arndt; Chief Financial Officer; Prologis Inc
Chris Caton; Managing Director, Global Strategy and Analytics; Prologis Inc
Daniel Letter; President; Prologis Inc
Hamid Moghadam; Chairman of the Board, Chief Executive Officer; Prologis Inc
Blaine Heck; Analyst; Wells Fargo Securities, LLC
Nick Joseph; Analyst; Citi
Ronald Kamdem; Research Analyst; Morgan Stanley, Research Division
Steve Sakwa; Analyst; Evercore ISI
Camille Bonnel; Analyst; Bank of America Merrill Lynch
Jonathan Petersen; Analyst; Jefferies
Caitlin Burrows; Analyst; Goldman Sachs Group, Inc.
Nicholas Thillman; Analyst; Robert W. Baird & Co.
Vikram Malhotra; Analyst; Mizuho Securities USA LLC
John Kim; Analyst; BMO Capital Markets
Vince Tibone; Analyst; Green Street
Ki Bin Kim; Analyst; Truist Securities
Michael Mueller; Analyst; JPMorgan
Michael Goldsmith; Analyst; UBS Equities
Todd Thomas; Analyst; KeyBanc Capital Markets Inc.
Nicholas Yulico; Analyst; Scotiabank GBM
Presentation
Operator
Welcome to the Prologis second quarter 2024 earnings conference call. (Operator Instructions) As a reminder, this conference is being recorded. I'd now like to turn the call over to Justin Meng, Senior Vice President, Head of Investor Relations. Thank you. You may begin.
Justin Meng
Thanks, Darryl. Good morning, everyone. Welcome to our second quarter 2024 earnings conference call. The supplemental document is available on our website at prologis.com under Investor Relations.
I'd like to state that this conference call will contain forward-looking statements under federal securities laws. These statements are based on current expectations, estimates, and projections about the market and the industry in which Prologis operates as well as management's beliefs and assumptions.
Forward-looking statements are not guarantees of performance and actual operating results may be affected by a variety of factors. For a list of those factors, please refer to the forward-looking statements notice in our 10-K or other SEC filings. Additionally, our second quarter earnings press release and supplemental do contain financial measures such as FFO and EBITDA that are non-GAAP. And in accordance with Reg G, we have provided a reconciliation to those measures.
I'd like to welcome Tim Arndt, our CFO, who will cover results, real-time market conditions and guidance. Hamid Moghadam, our Founder and CEO; Dan Letter, our President; and Chris Caton, Managing Director, are also with us today.
With that, I'll hand the call over to Tim.
Timothy Arndt
Thank you, Justin, and thank you all for joining our call. We had solid execution against second quarter plan, which showed improvement over the first quarter, underpinned by a pickup in overall market activity. In fact, we released 52 million square feet in our portfolio, a 27% increase over the first quarter and one of our highest quarters in the past few years. This helped in delivering occupancy, which outperformed our forecast, and more importantly, rent change well over 70%. This was achieved in an environment where decision making has remained slow as many customers optimize existing footprints before committing to new space.
As a result, we expect many property owners to continue to prioritize occupancy in select markets with higher availability, keeping pressure on rents. That said, the bright spot continues to be the depletion of the supply pipeline and successive quarters of very low development starts. We believe we are near peak vacancy in this dearth of new supply, setting the stage for more favorable conditions in 2025. As evidenced by very strong rent change this quarter, our lease mark to market is serving to sustain meaningful growth through this transition.
In terms of results for the quarter, core FFO excluding promotes was $1.36 per share and including net promote expense was $1.34 per share. We earned promote revenue within our fee per vehicle in Mexico, marking the 7th year of such achievements since its IPO and speaking to the high quality of our portfolio and team in that market.
Global occupancy at our share ended the quarter at 96.5%. Our US portfolio continues to outperform the market by over 320 basis points, a meaningful spread that has widened from our historic norm of roughly 175 basis points. As vacancy normalizes in our markets, we expect this flight to quality and to continue.
We crystallized $100 million of our lease mark to market during the quarter. As of June, we estimate that the net effective market rents are 42% above in-place rents, representing $2 billion of potential NOI. Over 40% of the decline in our lease mark-to-market ratio is due to this quarter's mark to market capture.
Net effective rent change was nearly 74% based on commencement and is 64% based on new signings. This metric can be volatile between quarters due to mix. But we continue to expect full year net effective rent change to be above 70%, illustrating the outsized mark to market opportunity that will remain in the near and intermediate term.
Our same-store growth was 7.2% on a cash basis, 5.5% on a net effective basis, each strong despite the impact of over 100 basis points of decline in average occupancy year over year, as well as the effect of fair value lease adjustments on net effective growth from the Duke acquisition. We deployed over $700 million into new development projects and acquisitions during the quarter and also closed on over $1 billion in dispositions and contributions at values exceeding our initial expectations.
We continue to grow our solar energy business with the installed capacity of our operating portfolio now at 524 megawatts with an additional 134 megawatts currently under construction. The total of which will generate approximately $55 million of NOI stabilized in line with our forecast.
Finally, we raised $1.2 billion of debt across our balance sheet and funds at a weighted average rate of 4.4% and a term of 11 years. Outside of this total, we also launched our $1 billion commercial paper program, which has thus far saved an average of 60 basis points on our short-term borrowing costs in the US.
In terms of our markets, there are several encouraging signs for demand, including port volumes on both the East and West Coast, as well as increased volume of proposal activity we've seen across our portfolio. While overall leasing has increased since the first quarter, the tone of our conversations with customers was continued caution in the near term. Even though space utilization sits at near and normal range of approximately 85%, we find that many customers simply lack urgency still prioritizing cost containment in light of an uncertain economic and political environment, both of which will be clearer soon.
In the meantime, development starts remain muted and below pre-COVID levels. Quarterly completions peaked last year at 140 million square feet and are projected to approach 50 million square feet by the fourth quarter of this year. We estimate vacancies in our US and European markets will peak over the next few quarters, likely creating a shift in tone as customers assess the requirements heading into 2025. Until then, rent growth will be anemic in most markets and down modestly in some.
Southern California remains its own story where demand remains sluggish, and vacancy continues to drift higher. While we've observed some green shoots over the last 90 days, we expect soft conditions to persist over the next 12 months. Globally, we estimate that effective market rents declined 2% during the quarter with 75% of the decline attributed to [Sunoco].
Because there's so much conflicting data available to investors, it's worth mentioning that we measure market rent growth by evaluating effective rents achieved, not asking rents before concessions, a difference that can be as wide as 5% to 10%. We've summarized by highlighting that most of the puts and takes across our global portfolio have provided conditions that are largely stable, with reason for intermediate term optimism due to several quarters of low starts and subdued to positive demand.
Turning to capital markets, value some modest increases in the second quarter for our US and European funds. There's greater depth amongst buyers of logistics properties and lenders are more active, together reducing yield requirements. In particular, buyer pools for well-located core product are growing now with multiple bidders back in the mix.
We saw this very clearly in a large portfolio sale we close this quarter, which was originally brought to the market last fall. Interest was reasonable at the time, but we felt pricing was off elected to wait and achieved 28% higher value in the end.
I'd like to provide a brief update on our data center business where we are having very good momentum across our pipeline. As you know, access to power is the key to unlocking value. And our dedicated energy and sustainability teams are leveraging our expertise in net zero carbon solutions, solar generation, and battery storage to ensure we are in the pole position with all of the major utilities.
To date, we have secured 1.3 gigawatts of power. Of this, 450 megawatts is currently under construction and $1.2 billion of TEI. 300 megawatts is in active predevelopment with an expected $700 million of TEI, leaving 550 megawatts is available and currently undergoing build to suit discussions. Beyond all of these, we are also in advanced stages of procurement for an additional 1.5 gigawatts, which is key to delivering on our five-year outlook for $7 billion to $8 billion of total data center investment. Overall, we've made significant progress growing this business and are optimistic about the targets we laid out at our Investor Day.
Turning to guidance, we are making few changes as the years playing out to our expectations. As such, we're maintaining our forecast for average occupancy, same store, G&A, development starts, and stabilizations. There only a few small changes otherwise. We are lowering our guidance for strategic capital revenue by $10 million, only to account for the impact of FX rates, which are hedged elsewhere in our P&L and will not affect overall earnings.
Due to increased activity we're seeing in the capital markets and deals completed year to date, we are increasing our acquisitions guidance to a new range of $1 billion to $1.5 billion, and similarly, increasing our guidance for overall dispositions and contributions to a range of $2.75 billion to $3.65 billion.
Ultimately, we increase our gap earnings to a range of $3.25 to $3.45 per share. Core FFO, excluding net promote expense, will range between $5.46 and $5.54 per share, while core FFO including promotes, will range from $5.39 to $5.47 per share, a slight increase at the midpoint from our prior guidance attributed to the fever promote.
Our core earnings guidance calls for nearly 8% growth at the midpoint, which ranks in the 87 percentile of S&P 500 rigs. We've been unique in our ability to generate leading growth over a long period of time, not only through a superior business model and portfolio, but also from our commitment to leveraging all that comes from our scale, including adjacent verticals strategic to our core business. Our focus is simply to continue to deliver on this industry-leading and durable growth.
As we close, I'd also like to highlight an upcoming event, our annual GROUNDBREAKERS thought leadership forum on October 2 in London. The program is taking shape is our best yet, exploring the surprising intersection of logistics and health, energy, and even fashion. Additional information for the forum is available on our website, and we hope to see you there or online.
With that, I'll hand the call back to the operator for your questions.
Question and Answer Session
Timothy Arndt
(Operator Instructions) Blaine Heck, Wells Fargo.
Blaine Heck
Thanks, good morning out there. It looks like your occupancy and rent spreads improved as the quarter progressed. Just looking at results versus the [Navy] update. Can you just talk about whether that momentum has continued into the third quarter, if there are any specific market that might have driven that improvement? And related to that occupancy guidance, the maintained guidance implies some downside during the second half of the year, can you just talk about what's driving that trajectory, please?
Timothy Arndt
Hey, Blaine. It's Tim. I'll start with the first part, and I may ask you to repeat the second. I'm not sure if I understood the question.
But coming into the first few weeks of the third quarter, I think we are maintaining the momentum that I guess you're inferring was picked between [may read] and the end of the quarter, which is there that proposal activity is strong, leasing activity is strong, we see it more in renewables and a little less so in new leasing. We're achieving our rents outside of the drag that we discussed. And SoCal just continues to be in the market that we watch most. But I think when I see put that all together, what we think is we're pleased to see the way the second quarter executed, I think it executed pretty much precisely as we expected from our discussion 90 days ago and feel good about the year.
Justin Meng
Thank you, Blaine. Operator, next question.
Operator
Craig Mailman, Citi.
Nick Joseph
Thanks. It's Nick Joseph here on for Craig. Maybe just on the demand side, obviously, it sounds like you're seeing and feeling an improvement there. But I was hoping you could talk about some of the demand differences across different size rate case in geographies.
Chris Caton
All right. Thanks for the question. It's Chris. I'll start with the geographies.
The healthiest part in the US is the southeastern US, but it also really pointing out Latin America as well as Europe as being areas that are boost overall global picture. As it relates to size categories, the story remains the same relative to what we discussed on our last earnings call, which is to say sizes above 100, maybe even certainly over 250 and 500, that's where demand momentum is the best. But there's also more availability there. It's stable below 100, but that's where vacancies are especially as well.
Justin Meng
Thank you. Operator, next question.
Operator
Ron Kamdem, Morgan Stanley.
Ronald Kamdem
Great. Just a quick question on the rent growth conversation. I think you talked about down to in 2Q after being down 1% in 1Q '24. Maybe if you could just provide some commentary on what the expectations are for the back half of the year. And the 46% rent growth targets long-term, how you guys think about that going forward? Thanks.
Timothy Arndt
Hey, Ron, thanks for the question. It's Tim. Yes, and let me start, I'll just reemphasize. We're talking about effective rents here from all the stores that we see out there and quotation. So this is ultimately taking rents, incorporating all concessions.
Starting with the next 12 months, I'll do it that way, as we've described we would, we talked about at [may read], we basically would divide our portfolio into SoCal as its own special case and then everything else. And within everything else, there are strong, stable and weak markets. And I would put all of those other non-SoCal markets around flat, maybe modestly negative on market rent growth over the next 12 months, which is a long way of saying it's really going to be a function of what do we think SoCal does in the next 12 months.
When we put that altogether, inclusive of SoCal, we would probably put that in a range of something like 2% to possibly 5% down in the next 12 months before inflecting. And this is a good place to just remind everybody that even in light of that -- I mean, we've had three quarters now of some negative market rent growth, one down in the fourth quarter of last year, one down first quarter, two down this last second quarter.
In the meantime, we're putting up very significant rent change and growth within our NOI. 74%, one of our highest quarters just this last quarter. So it's very fortuitous, the position we're in. We have this large lease mark-to-markets to carry us through this transition period.
Justin Meng
Thank you, Ron. Operator, next question.
Operator
Steve Sakwa, Evercore ISI.
Steve Sakwa
Yes, thanks. I think you commented on the lease proposals, but I was just wondering if you could provide a little bit more detail. Obviously, that green line is up strongly to the right. And I'm just curious how much of that is for new activity or vacant space or development? And how much of that might be for renewal activity just to frame it out because that number is up quite a bit even from the past couple of years.
Timothy Arndt
It is, and thanks, Steve. The chart you're looking at in the supplemental is new leasing, just to be clear. And you highlight something that I'm glad you did.
We do see the very big uptick in nominal proposals, 112 million square feet meaningfully above where we've been. That's a function of a few things there. One, it's just more space to lease. We have some increased vacancy in the portfolio, and this is also a function of just how the next 12 months will look and others a little bit more there as well.
This is why we added, for those who have noticed, a new line just this quarter, which puts that proposal activity in the context of what is available to lease. You see that measure, that 42% this last quarter, which we would characterize, and you can see when you look at the chart as normal.
Justin Meng
Thank you, Steve. Operator, next question.
Operator
Camille Bonnel, Bank of America.
Camille Bonnel
Good morning. The pace of development stabilizations seems to be tracking ahead this halfway point of the year. So I was wondering how does this compare to what was budgeted in your guidance. And on the West Coast, it looks like you've made some good progress stabilizing some of these development. So can you talk to some general terms on rents versus underwriting, and how much of that with new leases signed in the quarter? Thank you.
Daniel Letter
Yes, thanks for the question, Camille. This is Dan. I'll handle the question here.
So it was a big stabilization quarter for us. Certainly, development leasing has slowed a bit. I think the best way to look at our development portfolio is look at the whole book of business. Don't look at it necessarily on a quarter-by-quarter basis.
So if you look at the whole $6 billion development portfolio, all 35 million feet, we're trending to our long-term margin of 24% to 25%. So if you look at our 20-year average into the high 20s, so we feel really good about our development portfolio.
Justin Meng
Thank you, Camille. Operator, next question.
Operator
Jon Petersen, Jefferies.
Jonathan Petersen
Great. Thank you. So I was looking at your top tenant list. It looks like an increase in square feet leased to Amazon and Home Depot. We're hearing from other people that Amazon is more active this year. What do you want to talk about them specifically or maybe we can frame it in the context of -- what impacted some of the larger players in the market being more active in leasing have on the overall market? Like our people waiting for them to make decisions before we start to see an uptick in activity. Is that what's happening right now?
Daniel Letter
Yes, Jon. Hi, this is Dan. Thanks for the question. So what you're pointing to is our top 25 list where you saw some big completions come into the operating portfolio. Those are decisions that were made of a year ago. And sure, we've had some success with Amazon this year.
I would actually talk about the e-commerce segment overall. E-commerce has been very strong. We talked about this happening multiple quarters ago before it was a story, and it's played out as exactly as we expected. E-commerce continues to be strong. Amazon was a little quiet out for us this last quarter. But at any given time, they're our top customer. We've got a lot going on with them and it's a very strong segment for us.
Justin Meng
Thank you, Jon. Operator, next question.
Operator
Caitlin Burrows, Goldman Sachs.
Caitlin Burrows
Hey, everyone. Maybe just on the transaction market. I think, Tim, earlier you mentioned how the depth of buyers is deeper and the disposition you did within a materially higher valuation now versus 2023. So I guess what are you guys seeing from an acquisition potential on your side who is selling and your opportunity there in the near term?
Daniel Letter
Hi, Caitlin. Thanks for the question. Yes, we have seen the transaction market open up -- I would say, normalize. We're hearing from the brokerage community that they're doing a lot of broker opinion values. So we expect to see the transaction market to continue.
We've had a lot of success in the disposition. We've outperformed across the board and our disposition business, which is why you saw us move our guidance up. We definitely take advantage of the market as it's opened up. And we have also been turning over all sorts of interesting opportunities in many markets around the globe, and we're really excited about our acquisition volume for the year.
Timothy Arndt
Yes, the other thing I would add to that, Caitlin, is that you have closed-end funds that are coming to the end of their lives. And those portfolios needed to be liquidated. And the investment is generally because of what's going on in their portfolio, not just in real estate, but also in other private asset classes need the liquidity because they have outstanding commitments. So there's pressure from those guys to realize these sales. And industrial real estate has been one of the places that their performance has been really great, and the crystallization of those values is important.
So a financial course of things, and yes, some deferred sales volume that was put on suspended animation for the last 24 months that's not coming to. But generally, I would say that transaction market is very tight right now with multiple offers for good portfolios. And the sweet spot is a couple of hundred million, I would say. Not mega deals and timing deals, but in the $100 million, $200 million.
Justin Meng
Thank you, Caitlin. Operator, next question.
Operator
Nick Thillman, Baird.
Nicholas Thillman
Hey, good morning out there. And Tim, you mentioned the uptick in new lease proposals. Maybe I just wanted to dig in on retention for the next 12 months. Are you expecting that to the historical averages and then also continue to see free rent uptake? As the elevated concessions, is that spur demand a little bit? Just want a little more color on that. Thanks.
Timothy Arndt
So Nick, thanks. On the retention front, we typically forecast between 70% and 80%, they think of it as 75%. And that's a good number. And I would characterize that as our expectations over the coming several quarters.
And then free rent, I think we may have discussed just recently. I would view free rent just reverting to mean levels. We had -- there's another area where we had some surge pricing, if you will, some much lower free rent over the last few years. And now the market as it normalizes at different pace in different places, it's coming back to a more normalized level as well.
Justin Meng
Thank you, Nick. Operator, next question.
Operator
Vikram Malhotra, Mizuho.
Vikram Malhotra
Good morning. Thanks so much for taking the question. So I guess just two parts, one, Chris, could you just update us on your view on the $175 million of net absorption, what you anticipate for the second half? And then I guess you also mentioned for the roll-in rent growth projection. Could you expand upon that in context of your three-year view that you provided at the Investor Day on occupancy and same-store NOI growth? Thanks.
Chris Caton
Hi, Vikram. Thanks for the question. It's Chris. So as it relates to demand, just for those following along in absorption, first quarter was 26, 27 million square feet. We have had a 43 in the second. And so we expect 40 to 50 million square feet in absorption. I think that's the tone that Tim had in his script and that we have here on the call for you. That will leave you as for the full year net absorption of 160 to 170 million square feet. Tim's going to take.
Timothy Arndt
Yes, Vikram. In terms of the three years, the way we think about that, we clearly have an environment now where the window of time that we think about, the three years, has shifted. We've highlighted that we think rents are going to continue to fall modestly in the coming 12 months, grow thereafter. But the time that is then left to measure up to the end of 2026 is, of course, been shortened.
If we look at that same period, the end of '23 to the end of 2026, our sense is that rents are going to be flat then to modestly positive over that entire period. But we would couch that as rent that's really been deferred that the windows moving and that ultimately loss.
Hamid Moghadam
Yes, one of the perspectives I might provide to you is that the big change since our 4% to 6% per year forecast has actually been in concessions. So those concessions have -- I mean, in other words, if you have to forecast one for asking rents and one for effective rents, the effective rent one has been affected more since our Investor Day when we laid out that assumption. Not all of it, but face rents have come down in Southern California, certainly. But most of it has been expansion in the concessions. And we see those burning off over the next 12 months as market come into -- even the weaker market markets come into balance.
Just to give you a sense of something that Chris mentioned before, Southern California accounts for about 23% of our rents over the next 12 months. What we categorize as leakage market are another 21% of our rental profile for the next 12 months. And fully 56% of the rents rolling over in the next 12 months are in stable or healthy markets.
So on this isn't really a Southern California problem where it's both an expansion in concessions and reduction in base rent. Fortunately, and this is really important, Southern California is the market with the largest mark to market in the next 12 months, even with the decline that we are projecting. So there is pretty good downside protection, in fact, upside protection if there's such a word on those expiring rents in Southern California. So ironically, the weakest markets have the most mark to market, certainly, in the near term.
Justin Meng
Thank you, Vikram. Operator, next question.
Operator
John Kim, BMO Capital Markets.
John Kim
Thank you. I wanted to ask about the occupancy trajectory for the remainder of this year. At nearly, there was some discussion of this would dip below 96% in the near term and then recover. Is that Stellent on the table or are you now passed that risk, given the end of the quarter at 96.4%?
Timothy Arndt
Thanks, John. And I realize this was also Blaine's question that I missed earlier. So thanks for coming back to it. The 96 comment was very specific about where we thought the second quarter was going to land. I would say that the year-to-date average that we have so far around 96.6 year to date, the midpoint of our guidance is 96 in the quarter. That just reflects some tougher role so a little bit longer lease-up time that we see in new leasing. I hope it's conservative. I suppose there's a possibility, but we feel good about the range that we've established.
Hamid Moghadam
One other way of it, I think this was in Tim's prepared remarks. I think the quality of the portfolio manifests itself in two ways. It manifests itself in terms of premium in occupancy, which, if anything, has expanded in this market environment because when markets are really tight, people don't have a choice, they can't be picky about asset quality space, pretty much everything leases.
But as market get more normalized softer in some cases, business goes towards the higher quality business aside. It's hard to predict the absolute level of occupancy certainly quarter-by-quarter because one or two leases, even as large as our portfolio as can really move around the numbers. But I can tell you our premium, I'm very confident of our premium in occupancy compared to the rest of the market. I think it's going to expand even further.
Justin Meng
Thank you, John. Operator, next question.
Operator
Vince Tibone, Green Street.
Vince Tibone
Hi, good morning. Capital allocation guidance, it implies an acceleration of starts in the back half of the year. Are these all mostly plan logistics starts? Are there some data centers in there as well? And related all this, what markets would you be comfortable starting a spec projects today in the current environment?
Daniel Letter
Hi, it's Dan. Thanks for the question. So I think, well, first of all, your question around what's in our start volume. That is entirely logistics that you see there. And the better way to think about where we're going to build is look at the sheer amount of opportunities we have. We have $40 billion worth of opportunities in dozens of markets around the world. We've raised the bar on spec.
We take it through a rigorous process, pay attention to the market fundamentals, and I look at every deal on a deal-by-deal basis. So we have many markets around the world that will be building in this year. And I think decisions that we make on a deal-by-deal basis may change between now and when we start. So it's hard to peg anything certainly right now.
Hamid Moghadam
But if you're asking for specific names of markets, I would say Mexico is super strong. Nashville is then on the southeast, pretty strong and demand there. Northern Europe is very strong. So those are places you'll most likely to see spec development starts.
Justin Meng
Thank you, Vince. Operator, next question.
Operator
Ki Bin Kim, Truist Securities.
Ki Bin Kim
Thanks. Good morning. I want to talk about your data center business. Given the update you provided, at least from outside looking in, it seems like you're ahead of your five-year plan for 3 gigawatts of deployment. I'm not sure if that's correct, but maybe you could just comment on incremental changes in demand you're seeing in that business?
Hamid Moghadam
We are more optimistic about our data center business since the time of our Investor Day I think where some of those numbers come from event. Part of it is we've done some Exxon recruiting in terms of specialists in the sector that joined the team and are very excited. And secondly, the energy team that we have, the renewable energy team that we have has excellent relationships with utilities. And that's something that oftentimes is missing in a lot of data center companies that are just at the real estate component.
And obviously, we know the five hyperscale's really well. And in this environment, the ability to finance and deliver and execute becomes super important. These are mission critical deployments for these companies. And it is increasingly difficult for private players that don't have a balance sheet to compete in that market. So we think the competitive position of our largest, both because talent and balance sheet are just starting to get better and better going forward.
Justin Meng
Thank you, Steven. Operator, next question.
Operator
Mike Mueller, JPMorgan.
Michael Mueller
Yes, hi. Where do you think we are in terms of 3PLs resetting their footprints?
Timothy Arndt
Hi, Mike, thanks for the question. So the 3PL market is really an interesting dynamic right now. What we're seeing is certainly slack in the system, more acute in Southern California where they're simply just more 3PLs, almost double the average across the US. And that's where they took up a lot more space during COVID.
Now you can't deliver for our customer in a market that you don't have space, and a lot of the excess space that 3PLs have is scattered throughout their networks. By way of example, one of our top 25 customers came to us recently and said we have 6% to 7% excess space in our network. Yet a 750,000 square foot need emerged in a major market, which led to a long-term very large lease for us.
Hamid Moghadam
One way to think about the 3PL market is this. That 3PLs basically serve two purposes. Some 3PL business and volume comes from players that just want to outsource that activity to somebody else because they want to focus on their own business. And what I consider that to be baseload business, it doesn't act any differently than leases that are directly entered into by those companies, those principles.
Then there is the surge component of 3PLs. That is the component that is likely to be more volatile. On the way down when markets are becoming softer, you expect that component to actually suffer more. And when the markets are on the upswing, that's where you see the excess activities. The base part stays pretty consistent with the rest of the portfolio.
Southern California, to be specific, has in the low 30% range in terms of 3PL share of business. Now a lot of that is baseline business, but some of it is search business versus the average of the US, which is about 18% of the total portfolio is leased by 3PL. So obviously, those markets with bigger exposure to 3PLs have more of this problem on the search component.
Justin Meng
Thank you, Mike. Operator, next question.
Operator
Michael Goldsmith, UBS.
Michael Goldsmith
Good afternoon. Thanks for taking my question. You continue to remain confident on the intermediate term outlook, particularly on the demand side. So maybe just to sum everything up there that we've heard already today, what evidence do you see today that gets you excited? And then can you walk us through how you see the timing of that recovery playing out? Thanks.
Hamid Moghadam
Look, predicting market cycles, particularly when you've got a couple of wars going on, you've got a set that's had an inflection point with respect to interest rates. And you've got a presidential election coming up, which is, obviously, with the events of this, we can -- are highly volatile.
You got three major things going on. And to the extent that you're asking us for very specific forecast, let me tell you, we're not that good. And you should know that. But what gives us confidence, we can argue whether the full recovery, the market is 6 months or 12 months or 18 months.
I frankly think this is just my sense, having done this for 40 years, that the Southern California market center, the softness are going to stabilize the latest in about 12 months out. And the other submarkets are matter between now and 12 months, and more than half the markets are actually -- they don't need to recover because they've never unrecovered. They've been going straight up.
So I think you're talking about the next 12 months as various markets turn that the corner. And if we're going to pick a number, and I think if you get your head into January of next year, the presidential uncertainty will be done. I'm pretty sure that the Fed uncertainty will be done. So we'll be down to the political starts.
And what know for a fact, which is not a prediction, is that start volume is very low, and replacement costs have continued to go up. Construction costs have moderated. But exemptions on land and approvals and entitlements, those continue to go up. So I'm super confident about the long-term strength of our business. And calling get over quarters or even a couple of quarters is really difficult. But if you want an answer, you have it.
Justin Meng
Thank you, Michael. Operator, next question.
Operator
Todd Thomas, KeyBanc Capital Markets.
Todd Thomas
Hi, thanks. Me just following up on that a little bit. I'd be curious to get your thoughts on another maybe uncertain item, the potential impact tariffs might have on trade, and industrial real estate in the US, and just whether conversations you're having today with tenants are prospective tenants might be impacted as a result. And really, does that change anything? Potentially, how you think about allocating capital globally?
Hamid Moghadam
Yes. That's a really good question on. So first of all, I think there's a race between both parties on tariffs. I'm not sure which outcome is going to lead to more tariffs. Probably that Trump outcome, which is a higher probability at this point, is going to lead to more tariffs specifically on China. But at the end of the day, I think what you need to remember is that we are in supporting the consumption side of the supply chain. We've never focused on production end of the supply chain. So that same amount of goods volume of goods needs to get confused -- consumed in these markets.
With respect to specific tariffs like on China, all of that business as part of China plus one strategy of a lot of suppliers has already moved to other markets. Most of them are in Asia, a lot of them are in Southeast Asia. Some of it has shifted over to Mexico, particularly on the Northern Border.
But at the end of the day, they're going to get consumed where the people are in the US. So we don't see a radical demand shifts between markets or in terms of overall need for our product. So that's the main driver.
The second order effect is to the extent there are tariffs -- economics 101, you're going to have higher inflation, and that could cause the Fed to relax slower. And that will have obviously a headwind effect on the overall economy, which in turn will affect the demand for industrial real estate and everything else.
So I'm not worried at all about the primary effect, the direct effect of China, the way people think about this China-LA connection and the fact that that somehow going to be under pressure because that containers are going to land in LA. We don't really care where they come from. But the second order effect, which most people don't think about I think is important -- but that will be a problem in everybody's earnings calls if it were to materialize.
Justin Meng
Thank you, Todd. Operator, next question.
Operator
Nicholas Yulico, Scotiabank.
Nicholas Yulico
Hey, thanks. You've talked earlier about the transaction market pricing improving. Can you relate that to the strategic capital on revenue? Actually, we think about where the funds are valued right now and whether there could be upside potential revenue for that versus on the funds flow side? What you're seeing?
Hamid Moghadam
On our fund valuation, I can confidently tell you that we have turned the corner in both US and Europe. We were early adjusting our values, and I think we're now in the good side of the cycle. I think in a lot of other people's funds, they've been dragging their feet in adjusting the real value part of it. Some of it intentionally and some of it not intentionally because the appraisers are always backward looking. And until there's data and it takes time for data to reflect itself in the comp set, those values haven't adjusted.
So I think the market will continue to experience a decline in values. That really occurred 6, 9, 12 months ago, but are just not being acknowledged. I think we've already passed that, and our finance will be going up in value because of a more direct link between our valuation process, which is, by the way, independent. And that's really important to also understand. A lot of these funds don't do independent appraisals and others. So you may hear mixed messages on that, and that's just because we've been ahead of the curve.
As to the second part of your question, which is fund flows into industrial real estate, there is a tremendous amount of money that has been raised and not spend in acquisitions by investment managers. And my experience tells me that that money is going to get cement. And so I think that it's going to be the source of capital for a lot of transactions going forward.
In terms of new allocations to industrial real estate and everything else, remember, these portfolios are under a lot of pressure because they've had some office buildings that have declined in value 30%, 40%, 50%, 60%, which has been the biggest component of their portfolios. So they're under pressure and they're looking for more liquidity as opposed to being in a front foot forward investing mode. So I think the volume of new capital allocations to all kinds of real estate will be saw coming back, but it is on the upswing. It's just slower coming back than most other cycles.
All right. So I think that was a last question. Thank you again for your interest in the company. and everybody enjoy the rest of the summer. We'll see you pretty soon, hopefully, at GROUNDBREAKERS. Take care.
Operator
Thank you. That does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time and enjoy the rest of your day.