Kilroy Realty Corp (KRC) 2004 Q3 法說會逐字稿

Good day everyone and welcome to the Kilroy Realty's Third Quarter Conference Call. This call is being recorded and all participants are in a listen only mode. At the request of the company we will open the conference up for questions and answers after the presentation. I will now turn the conference call over the Richard B. Moran, Jr., Executive Vice President and Chief Financial Officer. Please go ahead, sir.

Thank you. Good morning everyone. Thank you for joining us. With me today are John Kilroy or CEO, Jeff Hawken, our COO, Tyler Rose, our Treasurer and Anne Marie Whitney, our Controller.

At the outset I need to say that some of the information we will be discussing this morning is forward looking in nature, please refer to our supplemental package for a statement [INAUDIBLE] in this call and the supplemental. This call is being webcast live on our web-site and will be available for replay for the next seven days both by phone and over the internet. A press release and supplemental package have been filed an a form 8-K with the SEC and are also both available on our web-site. We released our third quarter financial results yesterday afternoon. FFO was 62 cents a share. That includes high G&A expense as a result of our higher stock price and better than expected core earnings. I will talk about that more later in the call.

John will begin with an overview of the quarter an conditions in our key markets. I will follow with the financial highlights and updated earnings guidance. Then we'll be happy to take your questions. John?

Thank you, Dick. Hello everyone, thank you for joining us. I would like to cover three topics this morning. First I'll comment on the Southern California economy which continues to improve, second I'll give you my customary review of KRC's individual sub-markets, and third I will briefly discuss the range of new opportunities we are currently evaluating.

Let's start with Southern California economy. In summary, we continue to see improving market conditions and are pleased to see headlines in our local papers of the tightening supply of office space. Earlier this month, the Los Angeles Times reported what we've been seeing in our markets over the past several months, that businesses are are beginning to think think in terms of expansion not contraction, and that office occupancies, rental rates and absorptions are all showing signs of strength. While some businesses remain slow to make decisions, particularly in some of L.A., of the L.A. submarkets, in general companies of all types are beginning to look forward than over their shoulders. It is apparent in the regions shrinking vacancy rates and it's also suggested by the rising level of interest among business across a range of industries to extend their leases with favorable rates and to secure the availability of space in a tightening market.

The advance of optimism are supported by California's steadily improving economy. Job markets here continue to grow, particularly in Southern California, other economic indicators such as personal income, retail sales, and tax revenues all continue to improve. And the states significant manufacturing sector is also showing signs of growth as measure by Chapman University's Regional Activity Index and a rising volume of state manufactured exports leaving our ports. Statewide unemployment has declined nearly a full percentage-point over the past 12 months now stand stands at at 5.1%, as of September, with Southern California continuing to outperform. Unemployment in both Orange and San Diego counties remains below 4%. Los Angeles County's rate has now dropped to 6%. And all three regions continue to generate positive year-over-year job growth. Our experience in KRC over the past three months reflects these trends. We increased the occupancies in our stabilized portfolio to 93% up from 92% last quarter and 90% at year-end 2003. This is driven better than same store results and growth in core earnings.

Now let's briefly walk through KRC individual markets. San Diego County continues to attract strong interest from the a a broad range of companies seeking office space in one of the hottest economies in Southern California. Unemployment here is just 3.7% and year-over-year job growth as of September was 1.4%. The brokerage community currently reports some 6.9 million square feet of active demand in central San Diego which includes all of the market locations of our current properties in two future development sights. During third quarter our fourth key markets experienced positive net absorption of approximately 650,000 square feet, up from 450,000 square feet in second quarter.

In Del Mar, rising rental rates and robust demand from a variety of tenants make it the best in the county. Direct vacancy is currently 6.3% and total vacancy is 15.1% both down about a point from last quarter. Included in this submarket is our three building Del Mar corporate center that comprises 380,000 square feet and is now 99% committed to a variety of legal, health care and financial service firms up from 94% last quarter. Our Del Mar properties, which total over 1 million square feet, are now over 99% committed up from 96% last quarter.

Just south of Del Mar, the 15 million square foot Soreno Mesa market absorbed over 350,000 square feet during the quarter. The two-story product type in Soreno Mesa in which we compete has direct a vacancy rate of 10% and total vacancy of 12%, both down more than 2 percentage points since last quarter. Perhaps more meaningful is the change from the fourth quarter 2003 to the third quarter 2004. Overall vacancy rates are down from 25% to 14%, and in two-story product down from 24% to 12% and rental rates in the high quality two-story product in which we compete are up 30% year-over-year.

There are also encouraged to see in this market broad based job growth coming from the wireless sector from companies such as QualComm, Motorola, and Samsung. Combined with the growing demand and medical office sector and improvement in life science business we expect Soreno Mesa's market fundamentals to continue to improve. Our properties in Soreno Mesa are 99% leased.

The Rancho Bernardo market, where we also compete in the two-story product type, is also strengthening. The market absorbed 266,00 square feet during the quarter and vacancy rates fell fell almost 3 points. The direct vacancy rate is now 5% and total vacancy is now 9%. Our properties are 100% leased in this market. As we previously reported, we are underway with two office buildings in Rancho Bernardo that will total 103,000 square feet and have an estimated total investment of approximately 23 million. We have several promising discussions ongoing with potential tenants with those properties.

Finally, the UTC submarket has an 11% direct vacancy rate and 14% total vacancy rate. Our UTC properties are also 100% leased. Moving north to Orange county, our 3.9 million square feet of industrial properties are 97% leased and we recently signed and LOI for a 109,000 square foot building in this market that has been vacant.

In the Long Beach Airport market our 1 million square foot, seven building campus is now 91% occupied, up 2 points since last quarter. Overall the market has a direct vacancy of 7% and total vacancy of 10%. This market continues to produce the strongest performance of any market the entire South Bay region. We recently signed a seven year lease transaction with an engineering company for 32,000 square feet that will commence in January. Further north, the El Segundo market remains challenging, although overall vacancy rates continue to slowly improve. Quarter over quarter direct vacancy in the Class-A market is down 3% to 19%, and total vacancy is also down 3% to 21 %. Committed percentage at our recently renovated 999 Sepulvida building is up 10 points since last quarter and the building is now 56% committed.

In West Los Angeles we have also made progress. West L.A. was singled out by the Los Angeles Times as the most improved market in all of L.A. county this year. During the third quarter the market absorbed over 500,000 square feet of space. Direct vacancy fell to 13% from 15% and total fell to 14% from 17%. Our Westside Media Center reflects this momentum. We signed a number of leases in both Phase Two and Phase Three of this project during the third quarter with the as a result that Phase Two is 91% leased up from 87% last quarter and Phase Three is now 95% leased up from 69% last quarter. Phase One of the project remains 100% leased. This leasing progress bring it is overall project from 99% up from 82% last quarter. In our face Phase Three building we executed a lease with Chief Vortek TV which is a part of Comcast for 39,000 feet that will commence in March 2005. In addition Comcast agreed to extend its existing 78,000 lease for an additional ten years to 2010 at a higher rental rate.

So in summary are variations in intensity, the story is repeated across each of the submarkets in which we operate, strengthening demand, a growing volume of activity among an increasing number of potential tenants, solid progress in our leasing programs and a number of signals that suggest market fundamentals will continue to improve.

Our third point is to briefly mention the types of new opportunities we are currently pursuing given these market conditions. As mentioned, our confidence in markets as led to development on two new office properties in San Diego. These properties are expected to be complete in the third quarter of next year. We are also pursuing prospects to lease our existing 1.1 million million square foot pipeline of uncommitted future development. As Dick will mention in his comments about our 2005 guidance, we are forecasting we will have approximately 100 million of new development starts next year, although from an earnings perspective it won't have much impact till 2006. Beyond our focus on increasing our leasing performance in our existing pipeline, we are beginning to look at other development and acquisition opportunities. We're currently evaluating a few large transactions where there are existing assets with a significant development component. As we said before, we are not typically pursuing straight-forward building acquisitions given current cap rates, but we are interested in potential acquisitions that are both strategic to our existing markets where we have a concentration of assets and where we can add value over time through development or redevelopment. Development related transactions require a significant amount of time to complete and we will continue to update you as we progress. Now Dick will cover the financial results. Dick?

Thanks, John. FFO per share was 62 cents in the third quarter compared $1.17 in the third quarter of 2003 as we reported in our release. Last year's numbers included 48 cents a share related to [Peregrine] lease termination phase.

As I mentioned at the beginning of the call there are two things affecting our results that merit additional discussion. The first is the quarterly accrual of the company's long term incentive compensation program. This is a three year program that began in 2003 and runs through 2005. The amount ultimately [handled] under the plan will be based on our actual stock price performance from the three year plan from early 2003 to end of 2005. The plan is based on absolute and relevant stock price performance, and although the detailed formulas are fairly complex, the economic substance of the plan is equivalent to stock stock options where the strike price increases 10% annually. As I mentioned in past calls, the mark to market nature of the program requires a quarterly accrual that is essentially tied to the level of our stock price with a 1 dollar range in our stock price translating to approximately a 3 cents a share change in 2004 FFO. Since the inception of the plan our stock price has increased significantly, both our lease to equities and to other REITs. That in turn has required a higher accrual for the incentive compensation program. We ended the second quarter at $34 a share and this quarter this quarter at $38 a share, so the accrual increased in the third quarter by about 12 cents a share. Stated another way, our earnings for the quarter would have been 74 cents a sharer rather than the 62 cents share if the stock price had stayed the same in the quarter. All though there is no current cash impact of the plan we do include it in the SAD calculations which accounts for the 111% payout this year.

The second thing I wanted to cover is continuing improvement of the core results. Occupancy continued to improve in our stabilized portfolio during the third quarter, increasing to 93% from 92% at the end of the second quarter and 90% at the the beginning of the year. We saw improvement across all our major markets, including Los Angeles, San Diego and Orange counties. Broken down by product type, our office occupancy at the end of the quarter was 93%, up from 90% last quarter and 88% from the beginning of the year, Industrial occupancy ticked down to 93 from 95 last quarter.

Our year-over-year comparison in same store performance in the third quarter were also affected by the [Peregrine] settlement last year. Excluding the effect of the [Peregrine] settlement same store NOI would have increased 3% on a GAAP basis and 4% on a cash basis. The reason for this increase was almost entirely due to higher office occupancy. The first nine months of 2004 excluding the effect of the [Peregrine] settlement, same store NOI was up 5% of the GAAP basis and 6% of the cash basis.

In terms of rental rates both GAAP and cash rents were down in the third quarter versus the prior lease rates, a lot of which was due to the the Boeing lease in El Segundo that commenced in July. The rate on that lease is 25% lower than the prior lease, excluding the impact of the Boeing lease GAAP runs were up 9% and cash runs were down 6%. With the continued success of our leasing program in the quarter, our remaining expirations this year totaled just under 100,000 square feet less than 1% of our portfolio. We are also making progress on 2005 expirations, we have 1.1 million square feet expiring next year, slightly weighted toward industrial leases and we're already in negotiation on more than 50% of the total.

CapEx of the third quarter decreased to $4.3 million from down from $5.6 million in the second quarter, that includes $239,000 relating to building upgrades and 4 million in the form of normal TI's leasing commissions. We expect CapEx to remain relatively high for the rest of this year with all the leasing we've done. Our committed pipeline now includes two development projects in Rancho Bernardo we started last quarter and two projects in [Lisa]. We expect to spend with about $107 million on these four development or redevelopment projects with about $71 million spent to date.

Now let me turn to the the balance sheet. We continued our capital recycling efforts here in the quarter, selling a little under 277,000 square feet Industrial building in Orange County for $15.3 million which translates to a cap rate of 6.9%. We purchased the building in 1997 and had a gain on the sale of approximately $6.2 million. In the third quarter we also completed a private placement of $144 million of six and ten year debt at a rate of 6.14%, the transaction I mentioned in last quarter's call. And finally we just renewed our $425 million line of credit for our new three year term plus a one year extension option. The grid pricing structure was cut by roughly 13 basis points across the board we now have an an according expansion option to increase the line by up to an additional $125 million as our growth plans accelerate. Following these transactions our debt is now over 95% fixed for swap. Our average debt maturity is about six years, and we have no significant debt maturities maturities until 2008, and more than half our NOI is unencumbered. That positions our balance sheet well to take advantage of the potential acquisition and development opportunities John mentioned.

Now let me finish in with update on earnings guidance. Last quarter we provided 2004 FFO guidance in the range of $2.72 to 2.78 a share. Two things have happened since we gave that guidance. First, core results have improved, adding 4 cents to our earnings. Second, the increase in our stock price increased our G&A cost by 12 cents in third quarter and based on yesterday's closing stock price by a projected 2 cents in the fourth quarter. So net net positive trends and core results added 4 cents and high mark to market adjustment in our G&A costs translate to a negative adjustment of 14 cents. In addition, we've tightened our range a bit as we get closer to the end of the year. All in all, that results in new 2004 guidance of $2.63 to 2.76 for FFO which translates to guidance of 64-67 cents in the fourth quarter. As I mentioned, the special compensation plan that's causing volatility in our earnings runs through the rest of this year and 2005. 2005 is therefore the last year where our results will be affected by the special compensation plan. Next year as the plan gets closer to the termination, the sensitivity of the plan to changes in our stock price increases a bit. The rule of thumb thumb we're using is that a one dollar change in our stock price will affect 2005 earnings by approximately 5 cent as share. For 2005, our initial FFO guidance is a range of $2.70 to 2.90 a share. That assumes average occupancy of 93%, $50 million dispositions, no new acquisitions, but 100 million of development starts and flat G&A on a year-over-year basis.

That is a the latest news from here and now we'll take your questions.

Yes, the question and answer session will be conducted electronically. If you would like do do ask a question please do so by pressing the star key followed by the digit one on your touch tone telephone. Using a speaker phone please make sure the mute function on your phone is turned off so the signal can be read by our equipment. Once again, star one for questions. We'll pause a moment to gather our roster. We'll take our first question from Brian legg with Merrill Lynch. Please go ahead.

When are you say in your 2005 guidance that G&A stays flat, is that after these charges or do you are you assuming these charges sort of carry on into the next year.

We assume that our G&A inclusive of the special compensation charges for 2005, Brian, would be the same as the comparable number for 2004.

So is that implicitly saying the stock price goes up from here?

I'm sorry?

Does that say the stock price goes up from here?

No it assumes the stock price remains flat.

Can you talk about -- you didn't provide any -- you didn't talk about potential acquisitions next year, you said 50 million of dispositions, yet it sounds like you'll make some acquisitions opportunistically, can you talk about that and also talk about cap rates in your markets by submarket and also by product type.

Well, Brian, let me start and I'll turn it over to John. We haven't included acquisitions in our guidance, it's been our practice not to do so, we haven't done any acquisitions since very early 1998 as John mentioned. We are looking at some now where there's a development and/or redevelopment component included, so, more to come as things develop, as John mentioned. These things take time to put together, and for the specifics I'll turn it over to John.

I would only add to that as we we spoken on many calls with are with with regard to the inquiry as to acquisitions, we haven't been in love with the yields on acquisitions of completed buildings nor have we been particularly enthused with the quality of many of those buildings and to the extent they are not in our strategic markets they are dead on arrival anyway. What we're now seeing are some opportunities to buy fairly significant, terms dollar amount, existing projects that is have entitlements that are in our core markets in which we believe they make sense for us. For all of these reasons, and where the product is relatively new and products to be built obviously would be brand new, and the thing we liked about having the added development component is it allows us to what to move, what we would consider otherwise to be unacceptable or barely acceptable going in cap rates or IRRs to something that would be very acceptable. More to come on that. It is a little too early to give you an exact number, but I think over the next quarter or so we able to give guidance with regard of what acquisitions might look look like for next year.

Can you talk about cap rates for stabilized assets? Is it, are you talking sub-7% cap rates?

I think, this is Dick speaking, if we were just looking at buildings today for high quality buildings it could not be uncommon to see transaction prices in the 6 or 7% range. The situations we're looking at wouldn't be materially different from that initially but would have development and redevelopment components that could drive that return higher and during a visible term. It would take some time, but we would only, we're only interested in acquisitions where we can add real meaningful value just acting as a portfolio manager we are not convinced that it makes sense for us to do that. But where we can add value we do have an interest. So the initial returns would not be materially different than we think than the market -- the market is the market. But where there is an opportunity to add value we might have an interest, and typically I think our experience is, at least what I think we're seeing on the paper or on the computer screen now is that we're at the beginning of the development cycle. You typically see, in our experience, initial returns based on your pro forma when you look at current rents and current development cost, development cost tending to increase many the cycle more quickly than rents do. If you tend to look at returns that are -- that could seem subnormal, seem more like 9% or so on a cash basis, a little bit better on a GAAP basis. Then as the cycle matures a bit you typically, if things go according to schedule and go well, you wind up being able to build double-digit cash returns on a higher GAAP basis. I'm not sure where the fastest [INAUDIBLE] we'll see it as the cycle progresses, but that's at least that is what we're seeing right now is not inconsistent with what we've seen in prior cycles it's probably a more measured change in terms of timing. It is seeming to take time for things to change. Kind of a V shaped jump out of the previous recession, and I think we will probably wind up with a similar outcome.

Last question can you talk about the mark to market on your portfolio portfolio, and particularly for the 12% of leases expiring in '05 and the 14% in '06 I missed the same store growth assumptions for '05.

Same store assumptions for '05 would be about a 3% GAAP and 4% cash. And on a mark to market basis, as Dick said, were 0-5% above market as a portfolio and that's about where we are for expirations for next year as well.

Okay thank you.

We'll go next to Jay Leupp with RBC Capital Markets.

Hi, good afternoon, Jay Leupp here at RBC with David Copp. Can you talk a little bit more about the development yields beyond the initial acquisition yield when you are buying stabilized properties with excess land that would be acceptable to meet your investment investment hurdle criteria. Can you give us us any indication where these types of acquisitions that come with development land may likely to be. And lastly, are these going to be land parcels that you are going to have to work to re-zone or reconfigure or are they going to be fairly ready to development.

This is John, first with regard to your first question was yields on development for the properties that we are looking at requiring.

With the land component.

It vary as little bit. Let me first deal with the second question which I think is the geographic area. What we are looking at is all are in what we consider to be excellent core markets that Kilroy is now involved in. With regard to the development component that represent any where from a 50% to a 60 - 70% increase over what the initial investment in the existing buildings would be. And with regard to the yields, they are any where from a 9% up to a 10% going in projected cash yield with higher straight line yields.

To follow up on that, John, at this point in the market this period of 2004 are you actually seeing requirements in the the marketplace at this point that actually would include new development in their searches or still primarily existing building searches.

I'm sorry I didn't quite --

Are you actually seeing requirements in the the marketplace that would be tenant requirements that would be looking for for build to suit or some type of pre-leasing type of arrangement before they occupy or are you basically doing these on a speculative basis.

No, no, we are dealing with a vast number of companies, some of whom are house hold names that have some very significant requirements, generally from growth sometimes from a consolidation of 3 or 4 buildings and they want to locate in a new long term facility, but in most cases it is with pre-leasing in mind and I'd make and comment with regard to the whole issue of spec versus pre-leasing. We've been through many cycles as a company, and I would just kind of look at this the way -- share with you the way we look at it. Three years ago, we agonized on whether to start a building where we have a 15 year, 85% pre-lease commitment but we had, the market was deteriorating and we we finally decided to go forward with it because the the yields, just from that tenant alone, were acceptable. In other periods where we can see meaningful demand coupled with improving market fundamentals like we have today, our approach is to always make decisions on a case by case basis, but but we're going to try as best we can do some significant pre-leasing. In some cases we're working with tenants we know what their requirements are and frankly they can't make decisions within the time frame they need buildings and if the market fundamentals are excellent we feel that is an appropriate risk. That is the way we approach development in this point of the cycle.

Okay, and Dick, just one question. On your sale assumption for 2005 that's affecting your guidance, should we assume or are you assuming on that the same 6.9% that you achieved this quarter or are you being more aggressive or less aggressive?

We are being less aggressive, we would assume, I think an 8 1/2% cap rate.

We'll take our next question from David Loeb with Friedman, Billings, Ramsey Group, Inc.

I really don't want to beat the [INAUDIBLE] issue until its dead but what the hell, let's try. Dick you said that is non-cash at the moment?

The way it works, David, is it's a three year program where we accrue on a mark to market basis for three years then whatever is ultimately earned is based on the results over the entire three years then paid subsequently.

So it is paid in cash at the end of the three years?

Yes.

Okay, so that is why it is not being added back for cap because it essentially it will be cash.

Yes, it ultimately will be and I probably should have explained that for thoroughly, thank you for asking the question.

Any time. Can you talk about that lease termination reversal going back to an '0e transaction, can you explain what that was about?

That is related to a settlement we had from a lease termination fee from 2001.

We had a legal settlement on it.

Where you had to actually pay something back out?

Yes.

Yes was that [E-toys] or something different?

We can't comment further on it.

In a normal quarter that should be positive not negative.

Yes, it is a anomalous result.

Okay great, thanks.

We'll go next to Frank Graywood with Key Bank Capital Markets. Please go ahead.

On the provision for bad debts that was a negative adjustment. Can you talk about what that was was it? Was that Peregrine?

Yes, Frank, you may recall in a we -- in this part of the settlement we had an agreement that we we would receive subsequent payments from Peregrine over a period of several years, to the tune of roughly three-quarters of a million dollars each year in the third quarter. And at the time we said that the economic effect would be that we'd recognize those on a cash basis when we received them. From a GAAP point of view technically, what we had to was recognize them as revenue last year and then fully reserve against them, so rather than recording them as revenue when we received as we did in this quarter, we recorded them as a negative provision of bad debts. I'll let Anne Marie correct me I'm wrong in this, but a long time ago I was a CPA, but I think that is why we had a second anomaly, and I recognize it looks odd, but if we continued upon this path we could have similar adjustments as well.

Great. As far as long term floating rate debt strategy it is pretty low, .3%, what do you expect going forward? Are you going to let that swap expire?

I think so, good question. We probably, historically we always said we'd be in the 85% or so fixed range so we will probably let that that swap expire, that would be our current current plan.

Now, on the leasing that you've done, you've assumed pretty flat occupancies as far as '05 guidance. You think they're picking up. I guess, what would be your same store expectations for leases or for occupancies? I'm sorry.

For NOIs, or same store projections for next year would be 3% on a GAAP basis and 4% on a cash basis.

So however you get to that, all right. I guess, finally on the 909 Sepulvida, North Sepulvida, 19% is that all in service right now or does that include the lease with the engineering firm? I guess what percentage of of 909 is in service now, and then after January when the engineering firm comes in what percentage will be in service after?

The engineering firm is in Long Beach not in 909. What's in 909 is the Cars Direct lease.

I'm sorry.

It starts this quarter. I think it started at the end of October.

Okay, so the the total leasing on that is 19% then?

Yes.

Okay so starting, did you say October?

Yes.

Thank you very much.

Ladies and gentleman at this time we have one question remaining in the queue, we'd like to give everybody a final opportunity to signal by hitting star one on the telephones. We'll take our next question is from Ross Mussbaum with Banc of America Securities.

Hi, thanks, good morning, actually John Kim with Ross. I was wondering can you provide more commentary on the El Segundo market, I think you mentioned 999 Sepulvida is now 56% committed, then Cars Direct recently moved next door to 909. Are you seeing a more diversified tenant base interested in this market?

We are Ross, historically this was an aerospace and technical tech crowd and what we're now seeing is a far greater number of supplier category, still seeing a resurgence of the defense and aerospace, but it is far more diversified that it's been at any time since I've been in the market, which is my entire life.

So, these are tenants that are moving in other submarkets within L.A.?

There is a combination of growth in El Segundo, it is the largest market within the South Bay. South Bay is about 30 million square feet El Segundo is 10 million square feet and there hasn't been a new building built with any substance in South Bay in the last 6, 7 years. So as that market recovers, and as people look where they want to be El Segundo is a natural place to go, El Segundo has added a variety of amenities, a plethora of restaurants and shops and so forth that are in close proximity to the business community. So some of the things that the non-traditional El Segundo user needed are now in place and that's helping to attract people. The volume of of deals has gone up substantially in the last year, but still relatively low by historic standards, but we are seeing improvement and that is encouraging.

How would you describe the credit quality of some of these new tenants that you're having in Los Angeles, including BizRate and Cars Direct and the engineering firm.

Engineering firm has been around 4 years and has good credit. You'll have to speak with BizRate, [Carter], and [INAUDIBLE] with regard to Cars Direct.

I think John, this is Dick speaking, I think generally we are satisfied satisfied the the credit quality of the tenants. Where we're done leases, we've looked for either financial credit and/or long term business history and/or a combination of those two plus structure in the leases in terms of LC's or security deposits, so I think overall we are very satisfied. Obviously we have been very careful with the kinds of tenants we've chosen to lease to, but the guys we've chosen by and large we think they are a successful organizations that have a track record and a continuity that will continue. Obviously if you don't have some eventual credit losses you're not taking enough risk, if you haven't had a credit loss you didn't take enough risk, but overall I think we're pleased overall, if in part just a credit structuring mechanism as well as as an in depth look at the continuity of the business.

Final question what your plans at the this point for the 9.25% preferred units? Do you plan on refinancing those in the fourth quarter or paying them down?

I think we'll probably refund them John, I -- that is something we're looking at now. But that's something that just depends as the market continues, but my guess is based on market conditions it would be an attractive thing to do so I think we would probably refund them and keep them as part of the capital structure.

Okay. Okay, thanks a lot.

We'll go next to Sarah Blitz with Green Street Advisors. Please go ahead.

Yes can you talk a little bit about your leasing progress at your [Sorenta] Mesa redevelopment a seen on page 22 of the supplemental that it was 0% leased as of the end of the quarter?

That's right and we're in negotiation with a couple of tenants right now. That is a building that was in redevelopment, we were converting it to life science.

Okay but you don't have any -- you're just in negotiations right now?

That's right.

Can you also tell me the amount of NOI that you received in the quarter from both your project of lease outs and the projects that are under construction?

We received no income from properties under construction and no income from properties of lease out

Okay thank you.

We'll next to Dave AuBuchon with A.G. Edwards.

Quick question. John, in your prepared comments you mentioned a 109,000 square foot LOI in Orange County, I didn't catch if that was an industrial office building?

That is an industrial building, Dave.

Okay thank you.

Last question in the queue will be taken from Ralph Block with B.I.A. Financial.

Yes, can you give us any kind of color on whether you've seen any abatement in interest among institutions or private investors groups where your type of product and your locations or is it still as strong as ever.

Are you talking about for acquisitions, Ralph?

Right.

We're seeing very strong demand across the board haven't seen any abatement anywhere. And in many of these bids, situations, they'll literally be dozens of bidders and they get weeded down to two or three additional rounds. That is brings us back to why we are encouraged, seeing a little bit of light at if end of the tunnel with regard to acquisitions with development components, and one of the things we like about is that is it weeds out some of the more aggressive institutional investors because frequently they are only look at buying existing assets and don't want the development component. And I don't want to cut you off. I want to go back to a question somebody else raised, maybe it was Jay Leupp, with regard to entitlements. The projects that we're looking at in which there are existing buildings and development, the entitlements are in place for the development component. Sorry Ralph, I just realized I hasn't answered all of one question before --

No problem. Another question -- it's kind of an off the wall question, do you see any impact in terms of demand for your properties in terms of leasing from significantly higher gasoline line prices in Southern California? I mean, what the if gas goes to three bucks? I mean, how would that impact you guys?

I think obviously I'd have to speculate with regard to -- gas, by the way, is about $2.96, at least where I live in Malibu, so I don't know if that is as high it is it is everywhere else, it is probably higher. One of the things we've been most committed to in most of our projects and certainly since we've been a public company in almost all of our projects, be they acquisitions or be they new development, is to develop where there is a high concentration of where people live and it is convenient to access our buildings, where there are amenities, where it's close to freeway on and off ramps and so forth. So I think we are well positioned, about as well positioned as one can be, but when we we deal with the big macro issues you have to go to an economist. We have not seen any signs of resistance to any of your projects related to gasoline prices.

Okay thanks.

You're welcome.

Ladies and gentleman this does concludes today's electronical question and answer session. At this time I turn it back over to Mr. Moran for any additional remarks.

Thank you all for you you are interest in Kilroy Realty and we hope you all have a good day. Thank you.

Ladies and gentleman, this does conclude today's teleconference. If you'd like to listen to an audio replay of this call, you can do so by dialing 1-800-428-6051 or 1-973-709-2089 and entering access code 363263. A replay of today's call will be available starting today at 1 p.m. Pacific time and ending on November 3rd at Midnight. You may now disconnect. Thank you for you participation