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Edited Transcript of FIBRAPL14.MX earnings conference call or presentation 17-Oct-19 2:00pm GMT

Q3 2019 Prologis Property Mexico SA de CV Earnings Call

Oct 19, 2019 (Thomson StreetEvents) -- Edited Transcript of Prologis Property Mexico SA de CV earnings conference call or presentation Thursday, October 17, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Hector Ruben Ibarzábal Guerrero

FIBRA Prologis - COO & MD

* Jorge Roberto Girault Facha

FIBRA Prologis - CFO

* Kosta Karmaniolas

FIBRA Prologis - VP of Finance & IR

* Luis Enrique Gutiérrez Guajardo

FIBRA Prologis - Chairman & CEO

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Conference Call Participants

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* Adrian E. Huerta

JP Morgan Chase & Co, Research Division - Senior Analyst

* Alan Macias

BofA Merrill Lynch, Research Division - Analyst

* Andrea Lara Cid Antúnez

Signum Research - Junior Stock Market Analyst

* Eduardo Alvizouri Alvarez

GBM Grupo Bursatil Mexicano S.A. de C.V. Casa de Bolsa - Analyst

* Francisco Suarez

Scotiabank Global Banking and Markets, Research Division - Associate Director of LatAm Utilities

* Roberto Waissmann

Banco Bradesco BBI S.A., Research Division - Research Analyst

* Sheila Kathleen McGrath

Evercore ISI Institutional Equities, Research Division - Senior MD

* Vanessa Quiroga

Crédit Suisse AG, Research Division - Head of Mexico Equity Research & Co-Head of the Housing & Infrastructure in LatAm excluding Brazil

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Presentation

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Operator [1]

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Good morning and welcome to the FIBRA Prologis quarterly earnings conference call. My name is Jay, and I'll be facilitating the audio portion for today's interactive broadcast. (Operator Instructions)

At this time, I would like to turn the show over to Kosta Karmaniolas, Head of Investor Relations. Sir, the floor is yours.

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Kosta Karmaniolas, FIBRA Prologis - VP of Finance & IR [2]

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Thank you, Jay, and good morning, everyone. Thank you for joining us for our third quarter 2019 earnings conference call. Today, we will hear from Luis Gutiérrez, our CEO, who will discuss our strategy and market conditions; and from Jorge Girault, our Senior Vice President of Finance, who will review results and guidance. Also joining us today is Hector Ibarzábal, our Managing Director.

Before we begin our prepared remarks, I would like to remind everyone that all of the information presented in this conference call is proprietary and all rights are reserved. The information has been prepared solely for information purposes and is not a solicitation of an offer to buy or sell any securities. Forward-looking statements during this call are subject to a number of risks and uncertainties. Our actual results, performance, prospects or opportunities may differ materially from those expressed in or implied by the forward-looking statements. These forward-looking statements are current as of the date of this call. We take no obligation to publicly update or revise any forward-looking statements after the completion of this call whether as a result of new information, future events or otherwise except as required by law. Additionally, during this call, we may refer to certain non-accounting financial measures. As is our practice, we have prepared supplementary materials that we may reference during the call as well. If you have not already done so, I would encourage you to visit our website at fibraprologis.com and download this material.

With that, it is my pleasure to hand the call over to Luis.

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Luis Enrique Gutiérrez Guajardo, FIBRA Prologis - Chairman & CEO [3]

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Thank you, Kosta, and good morning, everyone. Our operating and financial results were solid. Let me start by discussing the highlights for the quarter. Our occupancy was above 95% for the 21st straight quarter, demonstrating that the location and quality of our buildings matter. Re-leasing spreads were negative in the third quarter due to the low leasing volume. In the first 15 days of October, we have already leased more than 900,000 square feet at re-leasing spreads approaching 20%.

Our focus remains on driving internal growth, and we will continue to push for higher rents and longer term while maintaining our elevated occupancy. On that front, cash same-store NOI was 2.4% for the quarter and 3.3% year-to-date.

Turning to the macroeconomic environment. Logistics real estate demand has been stable all year despite the weakening of the Mexican economy. While GDP has been revised down to less than 50 basis points for the full year, consumption is forecast at 1.2% and exports grew 6% year-to-date. Demand for our product is expected to grow approximately 4% or 8x GDP.

Overall demand remained healthy and in line with our expectation at the start of the year. However, the composition of demand has evolved over the course of the year with Monterrey and the border markets of Juarez, Reynosa and Tijuana making up 2/3 of the total net absorption year-to-date. Further to that point, year-to-date net absorption almost doubled in Tijuana when compared with the same period in 2018, while Juarez net absorption almost tripled.

Supply, which was greater concern at the beginning of the year, has had a notable slowdown for modern grade product development. Our expectation is for a balanced market with supply effectively on top of net absorption. Importantly, the supply pipeline, which is indicative of the leverage over the next 12 months, is approximately 1 million square feet lower at the end of the third quarter relative to the same period of last year, an indication that supply continues to be disciplined. The scarcity of land in Mexico City as well as the high cost of what is available, has acted as a governor of our overall supply. Putting it all together, vacancy was 4.4%, down 10 basis points year-over-year. Given our expectation for a balanced supply and demand in 2019, we would expect vacancy to end near the current levels.

Let me spend a few moments on our customers and what we're hearing on the ground. Across a wide variety of industries, customers have been actively pursuing expansions. We see this trend happening in all of our 6 markets. We continue to see interest from new American, Asian and European companies interested in establishing operations in our border markets as they explore near-shoring opportunities. Both new and existing customers in Tijuana and Juarez are actively looking for space. Sentiment has been positive with customers optimistic about future growth.

Our team in Guadalajara just renewed FIBRA Prologis' largest customer for 1.3 million square feet for a term of 10 years with a re-leasing spread in excess of 20%. On top of that, the team is working on several more renewals that should be completed before year-end.

E-commerce companies, which have largely focused their operations in Mexico City, have aggressively been pursuing a space in Monterrey and Guadalajara. In Mexico City, the space utilization has approached critical mass as our customers prepare for the peak operating season ahead of the holidays. This is a very strong indicator of future demand as evidenced by our robust leasing activity in the first few weeks of the fourth quarter. Our customers are pursuing renewal of the space and, importantly, at longer terms.

In summary, we remain committed to creating value for our certificate holders. E-commerce, which is emerging as a significant driver of logistics demand, is beginning to expand its supply chain as adoption by the Mexican consumer grows. We are well positioned for this, given our focus on the most populous market with the greatest per capita income. Our portfolio is resilient and built to outperform in any environment. We have excellent embedded earnings potential from the gap between in-place and market rents, which we will capture at lease expiration. We will remain prudent with capital, keeping a watchful eye on the macroeconomic and logistic real estate operating environment.

Finally, relative valuations versus rest of the world for quality logistics product remains attractive. With interest rates easing, along with an abundance of capital, we could see meaningful appreciation of our products.

And with that, let me turn the call over to Jorge.

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Jorge Roberto Girault Facha, FIBRA Prologis - CFO [4]

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Thank you, Luis. Good morning, and thank you for joining us. Starting with operations. Quarter end occupancy was 96.8%, an increase of 30 basis points year-over-year and 20 basis points from the second quarter. Leasing activity was 780,000 square feet this quarter. It's important to note that leasing starts are a function of 2 drivers: vacancy in the portfolio, which is small; and expirations. Of the 9 transactions this quarter, 84% were renewals and over half of the volume was in Mexico City. We have approximately 1.5 million square feet expiring in the fourth quarter, of which we already leased 2/3.

Net effective rent change on rollover for the quarter was negative 1.4% in dollar terms. Even though we only had 9 lease expirations, the negative rent change was driven by 2 leases that rolled down from above-market rents in Tijuana and Guadalajara. We expect rent change to be between high single digit and low double digits for the whole year.

Through the last 12 months, the weighted average net effective rent change on rollover was 8.5% in dollar terms. Additionally, it is important to point out that FIBRA Prologis in-place rents remain about 6% below market, providing us with embedded organic growth. Cash same-store NOI increased 2.4%, driven by higher contractual rent bumps and lower bad debt expenses, partially offset by the weaker peso.

Now let me turn to our financial performance. FFO for the quarter came in at $26 million, basically flat when compared to the same period last year. AFFO was $22.2 million for the quarter, up 2% when compared to the same period last year. The increase was based on lower CapEx.

Moving to our balance sheet. Our balance sheet remains one of the strongest in the sector. We ended the quarter with a loan-to-value of 32%, weighted-average debt cost of 4.5%, weighted average maturity of 4.1 years and $346 million of liquidity. We have positioned the portfolio and balance sheet to be in excellent shape and be ready for all parts of the market cycle.

Turning to guidance. We had a great quarter, and given that our results are in line with our expectations, we are keeping guidance unchanged. For more information, please go to Page 7 of the supplemental financial information.

To wrap up, we had a great quarter and are well positioned to end the year with strong operating results. We feel great about our business and confident about our future performance.

With that, I turn it to Jay for Q&A. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Sheila McGrath of Evercore.

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Sheila Kathleen McGrath, Evercore ISI Institutional Equities, Research Division - Senior MD [2]

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As we look towards 2020, you do have a higher-than-typical rollover year, and I was wondering if you could give us insights if you view that as an opportunity, where the rents -- market rents are versus expiring rents and which markets the rollover is concentrated in.

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Hector Ruben Ibarzábal Guerrero, FIBRA Prologis - COO & MD [3]

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Thank you, Sheila, for your question. This is Hector. Effectively, as it was mentioned in the opening remarks, we see our in-place rents around 6% below current market rents. I think that in the past, we have shown effectiveness on our ability to turn rents up to market, and this has been a consequence of a permanent rent growth that we have been presenting. Having said this, the largest expiration that we had, which is a second quarter transaction, a big customer in Guadalajara, it was mentioned as well in the opening remarks, it has already been renewed on a 10-year term, dollar-denominated, with above 20% market rent. So to answer in a straight manner your question, we do expect to keep on having a positive rent change on our renewals for next year, and this is going to be a good driver of our internal growth in 2020. Market has not slowed down, and we are positive about our strategy.

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Luis Enrique Gutiérrez Guajardo, FIBRA Prologis - Chairman & CEO [4]

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Sheila, in addition, the vintage of next year is 10%. So as you say, this will be an opportunity for us to keep our internal growth driver of rents.

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Operator [5]

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Next question comes from the line of Vanessa Quiroga of Crédit Suisse.

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Vanessa Quiroga, Crédit Suisse AG, Research Division - Head of Mexico Equity Research & Co-Head of the Housing & Infrastructure in LatAm excluding Brazil [6]

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My question is regarding the increase in expenses that we saw in the -- in this quarter compared to last year and compared to second quarter of this year. We saw an increase in some expenses that affect the NOI line. So can you provide color on what was the reason for this increase? And also, can you repeat the guidance that you mentioned for your expected rent change for this year, full year?

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Hector Ruben Ibarzábal Guerrero, FIBRA Prologis - COO & MD [7]

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Thank you very much for your question Vanessa. We do not provide guidance on rent growth, but I'm expecting a 2-digit rent growth at the end of this year. We have a very strong visibility of what's going to be happening. Regarding the increase in expenses, I need to be very clear that what you're seeing is a one-off transaction, is a nonrecurrent situation. The way our contracts work is that we have a reconciliation with our customers at the beginning of the year. So basically, all of the expense -- all of the operating expenses that we have are recuperated through our customers. So this somehow volatility that you could see in some quarters, this is the case in this particular quarter, is due to the situation. To avoid this, Prologis worldwide is introducing a concept, which is -- has been named a Clear Lease contract. With this Clear Lease contract, what we are doing is that we are taking advantage of the big data and our big customer base. So all these expenses are going to be fixed and our customers will have 100% certainty of what the total cost of lease is going to be. This has been introduced in Mexico for over a year, it has been very successful, provides certainty to everyone, at the same time, that will avoid this type of volatility that you are acknowledging.

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Operator [8]

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Next question comes from the line of Roberto Waissmann of Bradesco BBI.

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Roberto Waissmann, Banco Bradesco BBI S.A., Research Division - Research Analyst [9]

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My first question is regarding Guadalajara. We saw that occupancy significantly increased on both year-over-year and quarter-over-quarter basis and also increased in terms of rent per square meter. Could you give us a little bit more color on that? What should we expect from Guadalajara going forward? And the second question is regarding the net effective rent, the decreases in the quarter. You guys said it was mainly given 2 leases in Guadalajara and Tijuana. Could you tell us how much it would have been, the leasing spread, excluding these 2 contracts?

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Hector Ruben Ibarzábal Guerrero, FIBRA Prologis - COO & MD [10]

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Thank you for your question, Roberto. Effectively, Guadalajara was a positive surprise that we had within this quarter. We have some interest with one of the largest retailers that regularly leases temporary space from us in this season of the year. So the results that we are presenting are better than what we are anticipating which -- that is good news. The Guadalajara market scale with a reasonable absorption between 1.7 million to 1.8 million square feet, which is according to what we were expecting. And what we have been appointing in these sessions is the interest of new institutional investors jumping into that market. I think that in Guadalajara, we have a competitive advantage because of our location. Most of the new supply is going into the corridor of Chapala, which is further away from what the customers are looking. So I feel very confident that our assets in Guadalajara will be holding, and we will be able to get the better -- the best leases within that market.

Regarding the rent growth that you mentioned, yes, we did have a couple of transactions: one in Guadalajara in our periphery coastal project and the other one is Tijuana in our Pacific project. What we do is that, regularly, we take leases to market rents. In these 2 particular cases, the 2 leases were -- reached the end of contract with above-market rent, so we needed to adjust them. If we were to take these 2 leases out of the rent rolls, we should have had a slightly positive rent growth, probably between 1% to 2%. There was a certain noise regarding the low lease volume that we presented. When you have low lease volume as we did in this third quarter, when you have, in this case -- 2 specific cases can take the leases spread number down. However, it is important and somehow Jorge mentioned that in his opening remarks, the way we account lease volume is related just to the expirations that we had within the quarter. This is a very important message. Having a low lease volume does not mean that the market is slowing down. Having a low lease volume is a product of the turnovers that were appointed that were happening within this quarter. That's the only lease volume that we account. We did some early renewals, which are not part of these figures. Luis mentioned in his opening remarks, just in the first 15 days of December (sic) [October], we have exceeded everything that we did in the third quarter, and that's a clear evidence that the markets are holding in good manner.

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Operator [11]

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Next question comes from the line of Adrian Huerta of JPMorgan.

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Adrian E. Huerta, JP Morgan Chase & Co, Research Division - Senior Analyst [12]

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Two questions. One regarding that, Hector, that you were just mentioning. So what was the size of the GLA that was leased during the quarter that had expirations during the quarter? And then the second question is, if you guys can comment a little bit on asset sales. You continue to comment that there is a lot of appetite from investors to buy assets. What -- if we can still expect some asset sales to happen this year or is it something that we should move more towards next year?

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Hector Ruben Ibarzábal Guerrero, FIBRA Prologis - COO & MD [13]

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Thank you very much for your question, Adrian. The lease activity that we had was very small, and I already explained the reason for that was 780,000 square feet. I will pass the word to Luis to comment on the disposition strategy.

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Luis Enrique Gutiérrez Guajardo, FIBRA Prologis - Chairman & CEO [14]

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So thanks, Adrian. So let me touch on the environment first. So I think investors are looking for yields. Treasury is now reaching 1.7%, and we have been meeting with a lot of investors, and there's a lot of interest in getting into the sector, both on the private side and on the public side. So this has been a good change. And in fact, we can just cautiously say that Mexico could benefit from this interest in getting yields. So having said that, I think there is new entrants of investors from local and foreign trying to look for property. We always recycle our portfolios. We have set a guide of about $200 million. We already executed on $70 million. And certainly, additional dispositions depend a little bit on FX because there is a tax consequence depending on the FX. So we will monitor FX. And next year, if the FX conditions are in the right place, then we will act on it.

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Jorge Roberto Girault Facha, FIBRA Prologis - CFO [15]

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Adrian, just a quick comment regarding your first question. I think your -- the question was related to the 2 leases in Guadalajara and Tijuana. The size of those leases was around 280,000 square feet out of the 780,000 square feet.

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Adrian E. Huerta, JP Morgan Chase & Co, Research Division - Senior Analyst [16]

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And if I can just follow up on the asset sales. Is the interest from foreign investors mainly just on assets that have dollar rents or are foreigners also interested on those with peso rents?

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Luis Enrique Gutiérrez Guajardo, FIBRA Prologis - Chairman & CEO [17]

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I think the interest is in both. I think yield on peso and dollar assets are pretty attractive. Cap rates -- relative cap rates of Mexico are -- the spreads are wide. If you look at Mexico City, cap rates are between 6.75% and 7%. If you compare that to L.A., it's probably less than 4%. So that spread is very high. It's also very high to the 10-year. So I think a lot of investors are looking for that in pesos and dollars.

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Operator [18]

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Next question comes from the line of Eduardo Alvizouri of GBM.

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Eduardo Alvizouri Alvarez, GBM Grupo Bursatil Mexicano S.A. de C.V. Casa de Bolsa - Analyst [19]

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I have a follow-up question regarding the asset disposition and also on acquisitions. Can we expect some acquisitions in the upcoming year? I believe Prologis still have some properties and still development in Mexico, which could represent some interest in properties for FIBRA Prologis to acquire?

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Luis Enrique Gutiérrez Guajardo, FIBRA Prologis - Chairman & CEO [20]

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Yes. Thank you, Eduardo. And yes, certainly, there is 5.7 million square feet of property in the pipeline in which FIBRA Prologis has exclusive right to buy that, and this could be around $370 million. And they are 85% leased. So at this time, certificate is trading around 10% to 12% discount to NAV. So acting on these acquisitions would not be accretive to NAV. So we want to maintain prudency. We still see the political uncertainty internally and, certainly, the U.S. election is something to consider, as markets may be volatile. So I think we have 3 levers to act on these acquisitions: one is additional debt; number two is further dispositions; and number three is potentially issue equity should the certificate reach NAV. So having said that, we will remain prudent. We have optionality to act as we see markets evolve.

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Operator [21]

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Next question comes from the line of Francisco Suarez of Scotiabank.

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Francisco Suarez, Scotiabank Global Banking and Markets, Research Division - Associate Director of LatAm Utilities [22]

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Thank you so much for the initial remarks and clarifications on the overall trends on current leasing activities. That's very helpful. I do have a question on -- what about the prospects for extending the average life of the leases? Is that a possibility under current circumstances or that is actually a trade-off between earning those high spreads that you were talking about and the life of the lease? And secondly, also, if you can explain a little bit why the turnover cost increased so much in the quarter?

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Luis Enrique Gutiérrez Guajardo, FIBRA Prologis - Chairman & CEO [23]

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Thank you, Francisco. So as Hector mentioned, vacancy in our market is 4.4%. And if you break that down, Mexico City is around 2% and probably higher vacancies in Monterrey at about 7% or 8%. So as demand has remained healthy, customers are trying to lock their products. So we are seeing that customers are looking to lock their space and lock them for a longer term. So at 4.4% vacancy, we are still growing our rents and customers are looking to increase terms. So this is, I guess, healthy conditions. Now let me turn the call over to Hector. He can walk through the turnover cost.

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Hector Ruben Ibarzábal Guerrero, FIBRA Prologis - COO & MD [24]

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Thank you, Paco, for your question. We have been repeating that the turnover cost as a percentage of NOI should be between 10% to 12%. We have expressed as well that we are currently working on an LED program, trying to operate all of the facilities to have a better sustainability condition in the portfolio. The volatility that we had because of the low activity that we had is taking us to a 12.8% CapEx or turnover costs over NOI. This is slightly higher than what we have and this is due to the lighting program that I have been mentioning. We have been recommending to see the CapEx condition in our 4-quarter trailing average because if you do it this way, it's much better to understand the trend that we have in this panorama. The portfolio is in good shape. We have been regularly investing in CapEx in it, so we do not anticipate any major disruption in the current trends that we have been presenting over the past. Thank you, Paco.

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Operator [25]

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(Operator Instructions) Next question comes from the line of Andrea Lara from Signum Research.

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Andrea Lara Cid Antúnez, Signum Research - Junior Stock Market Analyst [26]

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I have some questions. First, I would like to know with what discount to NAV will you consider as a subsequent offering. Also, can you repeat GLA and the cap rates of the properties you are considering to acquire? Finally, can you give us more information of the impact that the lightning (sic) [lighting] program may have in terms of margins?

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Luis Enrique Gutiérrez Guajardo, FIBRA Prologis - Chairman & CEO [27]

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Thank you, Andrea. So certainly, for us, looking at the interest of all our shareholders and not to dilute them, we would be seeking the certificate to reach NAV. So that's when we would eventually pull a trigger on a follow-on. So the GLA to acquire -- you can look at the data at the supplemental, is 5.7 million square feet. Mainly 4 of those 5.7 are in Mexico City and 85% of them have already been leased. So they're pretty ready to be acquired by FIBRA.

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Hector Ruben Ibarzábal Guerrero, FIBRA Prologis - COO & MD [28]

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Let me refer to your third question, Andrea, regarding the lighting program. This is a program that Prologis has been launching globally and that has promised to be very successful. The main concept behind it is that we share with our customers the benefits, the savings on power consumption that this program represents. Eventually, all the money that is invested in this program will have a payback to our investors. And the return that we're expecting on this matter is even above the yields that we are receiving from the properties. It is close to a 2-digit return for these purposes. So eventually, within the next 3 to 5 years, we will be able to fully reconvert all the portfolio, and this will make a portfolio with a very green footprint, which is one of the principles that we have as a philosophical approach. Thank you very much, Andrea.

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Operator [29]

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(Operator Instructions) Next question comes from the line of Alan Macias of Bank of America.

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Alan Macias, BofA Merrill Lynch, Research Division - Analyst [30]

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Just a follow-up question on EBITDA margins. I guess if I understand this correctly, we should be seeing stable margins quarter-over-quarter for next year. And if you believe an assumption of margin of 76.5% is reasonable or is there opportunities to increase margins above the 70% level? Do you see that happening or not?

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Jorge Roberto Girault Facha, FIBRA Prologis - CFO [31]

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Alan, this is Jorge. Thank you for your question. Regarding margin on EBITDA, if you look at the last 4-quarter trailing, you will see an average of about 75% on EBITDA margin. I think that the margin on EBITDA is going to stay around those levels going forward. I would recommend you to look at AFFO margin, which is more indicative -- better indication for the type of company that we have, which is, in terms of average, you've seen the 54%, 55% number. This quarter, it was 55.6%, but if you look at the 4-quarter trailing quarters, it's about 55%. So answering your question, in terms of the EBITDA, you will see more of a 75% number. I would argue that you should look better on our AFFO margin, which is a better indication for the type of company that we run.

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Operator [32]

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(Operator Instructions) There are no further questions. Mr. Luis Gutiérrez, you may proceed.

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Luis Enrique Gutiérrez Guajardo, FIBRA Prologis - Chairman & CEO [33]

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Well, thank you, everyone, for joining today's call. As you know, I am the President of the FIBRA -- [and the] FIBRA, and we have a FIBRA Day event on October 29. So if you haven't done so, I hope you can join us on October 29 in the morning. In addition, if you happen to visit Mexico City, we would be happy to host you on a property tour. So with that, thank you very much, and see you in the next quarter.

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Operator [34]

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Thank you, again, for joining us today. This concludes today's conference call. You may now disconnect. Have a great day.