Kilroy Realty Corp (KRC) 2004 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Kilroy Realty Corporation's fourth-quarter 2004 earnings conference call. My name is Steven and I will be your coordinator for today. At this time all participants are in listen-only mode. We will facilitate a question-and-answer session toward the end of this conference. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded for replay purposes. I would now turn the presentation over to your host for today's call, Mr. Richard Moran Jr., CFO. Please proceed sir.

Thank you very much, good morning, everybody and thanks for joining us. With me today are John Kilroy our CEO; Jeff Hawken, our COO; Tyler Rose, our Treasurer and Ann Marie Whitney our Controller. At the outset I need to say that some of the information will be discussing this morning is forward-looking in nature; please refer to our supplemental package for a statement regarding the forward-looking information of this call and in the supplemental. This call is being webcast live on our website and will be available for replay for the next seven days by phone and over the Internet. Our press release and supplemental package has been filed in the form of 8-K and are both available on our website.

We released our fourth-quarter results yesterday afternoon. FFO was 53 cents a share versus our prior guidance of 64 to 67 cents a share. The difference largely reflects higher G&A expense resulting from our higher stock price during the fourth-quarter and the write-off of issuance costs associated with the redemption of our Series B preferred units. These costs were partially offset by better operating results; I will discuss that in more detail in a few moments. John will begin this morning with an overview of conditions in our key markets; I will follow with the financial highlights and updated earnings guidance and then we will be happy to take your questions. John.

Hello everyone and thank you for joining us. I would like to start with a few comments on economic conditions in our markets, then I will review our recent San Diego acquisition. And I will finish with my customary review of KRC's individual submarkets and discuss some specific leases we have executed since our last call. The economic story in California has been pretty much the same throughout the year, slow but steady improvement in job creation, particularly in Southern California and more robust growth in a range of other indicators including personal income, retail sales and tax revenues.

This has led to a further improvement in commercial real estate during the fourth quarter. During the past year statewide unemployment has declined from 6.5 percent to 5.8 percent and payroll jobs have increased by 152,000, a 1.1 percent growth rate. In Southern California markets unemployment rates now range from a low of 2.7 percent in Orange County, to 3.6 percent in San Diego County to 6.1 percent in Los Angeles County. All three regions generated positive year-over-year job growth.

The impact on commercial real estate markets has followed a similar slow but steady path. Each quarter we have seen a pickup in market activity, a reduction in vacancy rates across almost all regions, improving market fundamentals and a growing interest particularly in San Diego for new facilities from a range of businesses. And the strongest regional markets including San Diego County and more recently West Los Angeles, we've seen growth in rental rates.

For KRC 2004 was a year in which we focused first and foremost on our leasing program. That focus has paid off. During the year we signed new and renewal leases on over 1.9 million square feet of space, boosting occupancy in our stabilized portfolio by more than 4 percentage points to 94.6 percent. From a development perspective we started construction in 2004 on two new properties that will total 103,000 square feet in Rancho Bernardo along the I-15 corridor in San Diego. This is the market where we recently acquired a new project, Kilroy Sabre Springs, let me bring you up-to-date on this acquisition.

As we previously reported in December we completed a 98 million acquisition of two office buildings and the development site in the I-15 corridor submarket of San Diego. This acquisition fits exactly with what we have discussed on prior conference calls, which is to buy high-quality assets with growth potential in the best markets. In this case the subject assets are in a market where we already have the dominant position and essentially no vacancies.

Kilroy Sabre Springs is a new state-of-the-art, Class A office project that strategically expands our marketshare along the I-15 and 56 corridors, it diversifies our San Diego tenant base to include Intel, Nokia, Chase Manhattan and other strong credit tenants. It provides upside over time through below-market leases, and it allows us to use our development expertise to enhance the long-term returns on the project. Specifically we purchased two existing six-story office buildings that total approximately 282,000 square feet and are 90 percent leased with leases that we estimate are currently about 20 percent below market. The buildings were completed in 2002, were designed and built by the same architects and contractors who design and constructed many of our other San Diego properties.

The buildings were built to the standards we require in our other development in terms of overall quality, amenities and freeway identity. In addition, we purchased a fully entitled development site that will allow us to build a third six-story office building that will total approximately 143,000 square feet. The project is located at the intersection of the new 56 freeway and the I-15 freeway near our innovation corporate center in Santa Fe Summit property and down the road from our Delmar portfolio.

In terms of the development opportunity given the projects high occupancy and strong visible current demand it is our intent to start the third building later this year subject to prevailing market conditions. In summary, we believe this acquisition is a great example of how we have remained disciplined during a period of very aggressive asset pricing. This opportunity gives us two new assets with upside from below-market leases and occupancy growth and they were purchased at $319 per foot, which is well below replacement cost. We estimate that the third building will cost approximately $385 per rentable foot to develop and stabilize.

Dick will discuss the numbers for the acquisition later in the call. Now let's quickly walk through KRC's individual markets starting in San Diego. San Diego County remains the strongest market in Southern California real estate today. Year-over-year job growth as of September was 1.5 percent, and the numbers of businesses actively seeking new office space in the region continues to grow. The brokerage community currently reports that there is almost 7 million square feet of active demand in central San Diego, which includes all the market locations of our current properties and future development sites.

During the fourth quarter our 4 key San Diego markets experienced positive net absorption of 450,000 square feet. For the year our San Diego markets absorbed over 1.8 million square feet. In Delmar rising rental rates and robust demand from a variety of tenants made this the best of markets in the County. Direct vacancy is currently 5 percent, and total vacancy is currently 14.2 percent. Both down about 1 percent from last quarter. Our Delmar properties, which total more than one million square feet, remain 99 percent leased.

Just south of Delmar Sorrento Mesa's occupancy statistics also improved by about 1 percent during the fourth quarter. The two-story product type in Sorrento Mesa in which we compete now has a direct vacancy rate of 9.5 percent and total vacancy of 11.2 percent. Our properties in Sorrento Mesa are also 99 percent leased. The UTC submarket showed significant improvement in the fourth quarter with over 335,000 square feet of net absorption. This market has a 9.1 percent direct vacancy rate and an 11.8 percent total vacancy rate, down about 2 percent from last quarter. Our UTC properties are 89 percent leased.

Finally the I-15 corridor market which includes our Rancho Bernardo properties and our new Kilroy Sabre Springs project, also tightened during the fourth quarter. In the two-story product type the direct vacancy rate is now 4.9 percent, and the total vacancy is now 8.5 percent. The Class A direct vacancy is 8.6 percent, and the total vacancy is 9.2 percent.

Moving north to Orange County, our 3.9 million square feet of industrial properties are now 99 percent leased, up from 97 percent last quarter. In addition we just signed a 71,000 square foot renewal, and are close to signing an additional 150,000 square foot renewal both of which are industrial leases in Anaheim that were set to expire later this year.

In the Long Beach airport market our one million square foot seven-building campus is now 94 percent occupied, up 3 percentage points since last quarter. Overall the market has a direct vacancy of 7 percent and total vacancy of 11.3 percent. We do expect that the two Boeing leases totaling about 54,000 square feet that expire in our Long Beach buildings in the third quarter will not be renewed. We are actively working on backfilling this space and already have a strong prospect to take approximately 27,000 square feet.

Further north in the El Segundo market overall vacancy rates deteriorated slightly in the fourth quarter by about 1 percent. Direct vacancy in the Class A market is 21.3 percent, and total vacancy is 22.4 percent. Although the market is still sluggish with the improvement in the Long Beach and West L.A. markets coupled with a general improvement in the business environment, we expect that El Segundo will begin to strengthen, as well. El Segundo did absorb almost 450,000 square feet during 2004 and given the quality of our assets we captured more than our fair share of leasing. In addition we completed two significant renewal transactions in this market since our last call, totaling 400,000 square feet.

In December we signed a new lease with DirecTV that extended the existing lease term while adjusting the current rent to market. We also took more space. The details are as follows: DirecTV's original 183,000 square foot lease commenced in January 2001 and provided a right for DirecTV to terminate the lease at the beginning of 2006. We have executed a new lease but now expires at the end of 2011. It includes the original 183,000 square feet and an additional 24,000 square feet that DirecTV will take over the next several months as this expansion space becomes available. The rental rates for the existing space does not change in 2005, but adjusts downward by about 25 percent on January 1, 2006. The rate on the new space begins at the lower rate.

Second transaction in El Segundo was the renewal of the 192,000 square foot industrial lease with Mattel Corporation that was scheduled to expire in October '05. The new lease has a five-year term beginning this October and includes a rental rate about 12 percent higher than the current rate. In West Los Angeles the market absorbed 175,000 square feet of space during the fourth quarter and finished the year with 1.7 million square feet of net absorption. Direct vacancy is 11.5 percent, and total vacancy of 13.1 percent, both down about a percent from last quarter. And this is a market that is currently seeing additional improvement. We are told that about 450,000 square feet of transactions are about to be executed in the media district of Santa Monica, West L.A. near our 380,000 square foot Westside Media Center where we moved the amount of committed space up 3 points to 98 percent.

Along with the reduction in vacancy, we are now also beginning to see growth in rental rates. In the fourth quarter we saw about a 5 percent increase in rates to the 280 to 290 range full-service growth per month and we expect this trend will continue throughout 2005. Let me conclude by saying that although we can't predict what macro event may impact the economy, we continue to feel more positive in terms of tenant demand and the conditions of our markets. Our focus for 2005 is to broaden our marketing efforts and to continue our strong leasing momentum, to continue to look very selectively for potential acquisitions where we can buy at a discipline cost and unlock embedded value. And to utilize our unique development franchise to create value and generate superior risk-adjusted returns by building and leasing brand new, state-of-the-art market products in ground zero growth locations.

Now Dick will cover the financial results.

Thanks, John. FFO was 53 cents a share in the fourth quarter compared with 62 cents in the fourth quarter of 2003. For the year FFO was $2.52 a share versus $3.41 a share in 2003. As a point of reference our 2003 FFO including included 68 cents a share in large, out of the ordinary lease termination fees and reserve reversals, mainly related to the resolution of the Peregrine situation. This year's fourth quarter was negatively impacted by two items, our long-term compensation plan and the redemption of our Series B preferred units, offset partially by improved operating results.

In terms of the compensation plan we ended the fourth quarter with our stock price at $42.75 a share, up from $38.54 a share at the time of our last call. So the accrual in the fourth quarter was higher than we originally estimated by 14 cents a share. As we discussed in prior calls, the Company's special incentive program began in 2003 and runs through the end of this year. The amount ultimately payable in this plan will be based on our actual stock price performs at the end of the period. But the mark to market made for the program requires a quarterly accrual that is essentially tied to the level of our stock price. As we noted in our last call a 1 dollar change in our stock price translates to approximately a 5 cent a share change in 2005 FFO.

Second, as we previously reported we closed an $83 million preferred offering at 7.5 percent in December and redeemed our $45 million 9.25 percent Series B preferred units. In connection with the redemption we reported a $1.2 million non-cash charge to write off the initial issuance costs of the redeemed units. That had a 4 cent impact on fourth quarter results which wasn't in our initial guidance. Our guidance for the fourth quarter was 64 to 67 cents excluding from that the 4 cents from the preferred transaction and the 14 cents from the compensation plan, our adjusted guidance would have been 46 to 49 cents. Our actual results were 53 cents a share, so we ended up 4 to 7 cents higher than our original guidance. Two cents of the improvement was related to better-than-expected results on a legal settlement we mentioned in our last call. Our litigation with the eToys credit is over the letters of credit we collected when eToys went bankrupt is now completely resolved and on a more favorable basis than we originally anticipated.

The rest of the improvement was from improving results pretty much across the board as we continued to see solid performance in our stabilized portfolio. Occupancy in the portfolio increased another point and a half in the fourth quarter to 94.6 percent, up from 93.1 percent at the end of the third quarter and 90.3 percent at the beginning of the year. The improvement was broad based across Los Angeles, San Diego and in our Orange County market. Broken down by product type office occupancy at the end of the fourth-quarter was 94 percent, up from 87.6 percent beginning of the year, and industrial occupancy was 95.5 percent, up from 94.5 percent for the beginning of the year.

There is a couple of key observations that are apparent from our leasing progress in 2004. First, our profit (ph) results in all of our markets outside of Los Angeles improved from good to very good in 2004. That is reflective in our stabilized portfolio outside of Los Angeles where occupancy increased from 93.6 percent to 97.4 percent last year. And second, even though economic growth in Los Angeles has lagged the market here is improving. That shows up in our stabilized L.A. portfolio where occupancy increased from 81 percent to 86.5 percent in 2004. We hope that trend continues this year.

The improvement in occupancy produced increases in same-store NOI. GAAP NOI increased 5.2 percent and Cash NOI increased 6.8 percent in the fourth quarter. For the year GAAP NOI decreased 4.9 percent and Cash NOI decreased 4.4 percent. But excluding the impact of a 2003 Peregrine settlement GAAP NOI increased 4.8 percent and Cash NOI increased 6.0 percent for the gear.

Looking at rental rates Cash and GAAP rents on the fourth quarter were down 2 and 8 percent respectively; for the year Cash and GAAP rents were down 9 and 7 percent respectively. Most of the change was related to the Boeing lease that commenced last July and the DirecTV lease that John mentioned. Excluding the Boeing and DirecTV leases, fourth-quarter rents on the rest of the portfolio were down 4 percent on a Cash basis and up 4 percent on a GAAP basis. For the year rents for the rest of the portfolio other than the Boeing and DirecTV leases were down 4 percent on a Cash basis and up 7 percent on a GAAP basis. Both of our 2005 expirations and on a portfolio basis, we estimate that our leases are currently approximately at market.

A month into the new year we are making good progress on our 2005 expirations, we have about 1.3 million square feet expiring this year, just over half of which are industrial leases. And we have completed or are in negotiations in about half of the total. CapEx for the fourth quarter increased to $10.8 million from $4.3 million for the third quarter. That includes $4.1 million related to extending and expanding the lease with DirecTV our third-largest tenant in El Segundo. That $4.1 million will be paid out over three years.

The higher CapEx from the DirecTV lease combined with the accruals of the long-term compensation plan resulted in an abnormally high FAD payout ratio in the fourth quarter and excluding those two items the FAD payout ratio was 87 percent for the fourth-quarter and 83 percent for the year. Our committed development pipeline remains unchanged for the third quarter, it includes the two buildings we started in Rancho Bernardo last year and two buildings on lease up. We expect to spend about $111 million on these four developments and redevelopment buildings with about $77 million spent to date.

In other portfolio activity we completed two dispositions during 2004 totaling just over 400,000 square feet, generating total sales proceeds of $35 million. And as John discussed earlier, we completed the acquisition of Kilroy Sabre Springs office complex in December. The Sabre Springs acquisition is consistent with the acquisition strategy we've been talking about for a long time. It enhances our strategic position in a high-growth market; in this case North San Diego County where we already have the market leadership position. It also gives us the opportunity to create value both by unlocking the existing below-market rents over time and by expanding the project by over 50 percent on the adjacent development site. And we bought the existing buildings which were less than three years old below replacement cost and added another fully entitled development site to our pipeline which we think enhances our competitive advantage in attracting new tenants in what is one of the best office parks in the country.

From a number's perspective the acquisition has the following impact, the cost of the existing building was $90 million so $319 a foot. The cost of the development site was $8 million or $56 per FAR foot. The two existing buildings that stabilized Cash and GAAP cap rates are 7.2 percent and 8.5 percent, respectively once the free rent and the existing leases burns off at the end of this year. For 2005 the cash return is approximately 5 percent. The average rent on the in-place leases is approximately 250 per square foot per month on a modified growth basis which is well below market. We are currently in discussions with prospective tenants for vacant space in the project in the $3.15 range.

For the development site we have entitlements to build 143,000 square foot six-story Class A building that would cost roughly $385 a square foot and on a pro forma basis, we are generating additional stabilized Cash and GAAP returns of roughly 8.5 and 10 percent or so, respectively. Upon completion of the third building the overall yield on the entire project in the first stabilized year would be over 9 percent on a Cash and GAAP basis. From an earnings perspective the acquisition is expected to add approximately 11 cents a share in 2005, including 3 cents from a FAS141 adjustment required as part of the acquisition.

We funded the $98 million acquisition with our credit line. As I mentioned earlier, prior to that in December we completed a new $83 million preferred offering. Our net proceeds are for issuance costs and the redemption of our Series B preferred units were 38.5 million. In terms of other balance sheet changes that I mentioned during last quarter's call, we completed the renewal of our $425 million credit facility in October, lowering the cost and adding an expansion option that can increase the line by as much as $125 million in case our growth plans accelerate. The renewal extends the line for three years with an additional one year extension option.

We had a $50 million interest rate swap expire in January. That results in our debt being 84 percent fixed for a swap which is in line with our objectives. Now let me finish with an update on earnings guidance. Last quarter, we offered initial 2005 FFO guidance in a range of $2.70 to $2.90 a share. That assumed average occupancy in the mid 93 percent range, 50 million of dispositions, no new acquisitions and flat G&A on a year-over-year basis. Several things have happened since then. As John indicated on the DirecTV renewal, down (ph) the rent adjustment has no cash impact in 2005, it does have a GAAP impact of 4 cents a share in 2005 because of straight line rent.

Second is a forced net impact on our annual results taking into effect both the increased amount and the lower coupon of the preferred issue we closed in December. Third, short-term interest rates have increased roughly 65 basis points since our last call, which translates to 3 cents a share in higher interest costs. Four, there is an estimated 11 cent positive impact from the Sabre Springs acquisition, and finally in terms of the impact from the compensation plan since our last call, if the first quarter ended at yesterday's closing stock price of $39.08 our 2005 compensation plan expense would be lower by 11 cents a share.

So in summary, we started at 2.70 to 2.90, and we had three downward revisions including 4 cents for the DirecTV lease, 4 cents for the preferred deal and 3 cents for higher interest expense and two upward revisions including 11 cents for the Sabre Springs acquisition and 11 cents for G&A. Altogether that adds up to a net positive change of 11 cents. So taking all that into account along with everything else we're seeing, we're providing new 2005 FFO guidance today of $2.80 to $3.00 per share, up from 2.70 to 2.90 in the last quarter. That is the latest news from here, and now we will take your questions. Operator.

(OPERATOR INSTRUCTIONS) Louis Taylor of Deutsche Bank.

John, can you just go over that new DirecTV lease again? I didn't quite catch it all in terms of the extension and the additional expansion.

Yes, the original lease was 183,000 square feet, and it at a provision that starting at the beginning of '06 they could terminate. We have now extended to the end of 2011 with no right of termination. The rent through what would have been their termination right period, meaning through the end of this year, regains (ph) that the $3.09 per square foot full-service gross that was in place. And then it drops down to $2.35 per square foot full-service gross 1/1/06. In addition, they leased an additional 24,000 square feet, Lou, that they are going to take as that space becomes available over the course of the next several months.

John, what building are they in?

They're in the building that used to be our headquarters, 2250 East Imperial Highway, (indiscernible) airport center LAX.

Got it. Okay, John, at what point, I guess you had negotiations again with Boeing on the other Imperial Drive buildings? Is that kind of early stages right now, or is that something that is just kind of an ongoing discussion?

Well, it's an ongoing discussion. We also have some other folks that have an interest in that complex. And no offense to Boeing, but I think everybody knows it has been our intent to reduce down the size of the Boeing exposure at Kilroy. They are our largest tenant with what, Ty, at 7.5 percent, roughly?

Roughly.

Roughly, and of course that is going to fall a little bit further as we move them out of the 54,000 square feet down in Long Beach. Our long-term plan is to move the Boeing occupancy as a percentage of our NOI down significantly.

Okay. Second question is at 909 Sepulveda, just what is the leasing activity look like there?

Leasing activity last year in the city of El Segundo, they absorbed in the office market 450,000 square feet in Class A. It absorbed 400,000 square feet excuse me, of that was in Class A. The Class A market is roughly 4,900,000 square feet. 909999 represents about 8 percent of that. And we captured 22 percent, roughly 88,000 square feet of the 400,000 square feet of net absorption in Class A. We have a number of folks interested in the space. It is going to be a fairly long lease up, at least based upon the current El Segundo metrics. I would say positively that El Segundo has about 900,000 -- 1 million square feet of demand and pursuant to what the brokers tell us the majority of that comes from outside the market. So like we said in our formal remarks, we see the tightening here on the West L.A. market and further south in the South Bay market in Long Beach airport and so forth as the positive trends that we believe will positively over time impact El Segundo.

Okay, and just a couple follow-ups. Just what is the general tenant mood right now given the tightening market? Are they just looking to lock in deals longer-term or just lock them in before rates go up? I mean is demand being pulled forward a little bit given the tightening? What is the tenant attitude?

Well, it depends on the market. I would say generally speaking as we had been indicating all year and I think we feel even more strongly that there was a change a couple of quarters ago where it was becoming clear to tenants who had needs that it was becoming less of a tenant market. And I would say now the early signs here on the West side and more positively over the last year become more of a landlords' market. And we think that trend will continue throughout the area to all of our markets to varying degrees over the course of this year. In San Diego rents have gone up pretty substantially, we are forecasting that they are going to continue to go up. I think Torto Wheaton for San Diego is projected on average rents are going to increase something like 11 percent in San Diego. Brokers have varying predictions. While we are not willing to discuss what the amplitude will be, we can't say that direction is positive and we feel very strongly about our holdings and our development properties there.

In our industrial activity in Orange County by and large we're seeing rates start to increase. We do have the occasional transaction in the portfolio that has some rolldown because it was written back in '98 or '99 at the height of the market. But by and large tenant demand is strong. People are recognizing that they need to make decisions. Much of the sublease space in all of these markets as you can see by the statistics has been absorbed, and I generally say that we are feeling pretty positive about the trends.

Just two final questions just for Dick. Dick, what would your G&A in '04 have been -- I guess if the stock price was flat?

Stock price was flat for the year?

Yes.

Lou, I would have to go back and look. I just don't have -- one of the few numbers we don't have off the top of our head here.

And this last question for John or Dick. In terms of the prospects for a new compensation plan, is that likely to be a decision the board is likely to make in '05, or is it likely to be an '06 event when the current plan expires?

I think, Lou, we expect that they will probably take action later on this year. That is our request of them and our expectations so that we will be able to have predictability. As you know while we've been frustrated by the volatility that is inherent in this plan and the amount of time we've had to spend talking about it in our view is not terribly productive in doing so. So that is our request, and we hope that will come to fruition, (inaudible) more to come on that. That is obviously their decision.

Brian Legg of Merrill Lynch.

John, you said that you expect a long lease up at 909 but you have a stabilization date of the third quarter. Is that still on target?

The stabilization date is the date in which it becomes part of the operating portfolio as opposed to (inaudible) with redevelopment before that.

So you don't expect to get it leased before the third quarter is what you're saying?

No, no.

Okay. And just looking at your CapEx it was a spike up but you said there is 4.1 million from the DirecTV. Is it just looking at for '05 your CapEx, is as a good run rate to take 4.1 million out of the 10.8 million? And say 6 plus million per quarter?

We don't think it will be quite that high actually. It should be somewhat lower than that maybe in the 15 to $20 million range for the year.

Okay. And can you touch again on your expected development starts and also just looking at your pipeline, you didn't do a whole lot of leasing on any of the projects. Can you talk about the projects and lease up and sort of the activity on these projects?

At the two buildings that we started that are going to be completed here in three months or so, in San Diego totaling 103,000 square feet, they are actually buildings right next door to one another. We have very strong interest right now. We have what I would consider to be serious interest, 7 tenants totaling 400,000 square feet. The largest of which is sort of in the 125 to 150,000 square foot range. The rest would be between 15,000 and 75,000 square foot range. So we feel very strongly with regard to the positioning we have of those assets. We are already having some discussions with regard to the two remaining buildings totaling about 125,000 square feet on that site that we can build.

In regards to the 5717 building, 5717 Pacific Science Center in Sorrento Mesa which totaled 67,000 feet, we have a number of folks looking at that space, and we hope to have some decent news on that here within a quarter or so. The demand in that market has increased substantially as our rental rates beginning to increase substantially. So we think we are well-positioned. I can say that throughout the portfolio both with regard to our core portfolio where we have about 6 percent vacancy, 5 percent vacancy whatever it is and with regard to the projects that we have in our development heading, that we have very substantial demand across the board, El Segundo being the weakest, San Diego being the strongest. So we have progress to make, and we think we will make progress.

To the second part of the question, which is development starts for '05 we gave guidance last call, as I recall, that somewhere in the neighborhood of $100 million for the year; we think that is a good number. It could be more. That would be the 100 million is about five different four, five different buildings that add up to that number. And they are in the various markets that we have here in San Diego.

You said the demand has picked up for your 5717 Pacific Center --does that mean so Life Science in that market is picking up and would that mean that you might start a lab office building in that market?

I don't know that we would start one yet, but we do have interests both from other technical users as well as the Life Science market. With regard to Life Science as I think everybody knows, the market over the last couple of years I characterize it as one in which generally speaking has been a paramount of sublease space put back on the market and or put on the market; much of that has been absorbed. We have now seen positive '04 over '03 DC funding for the Life Science industry. We're beginning to see some of those companies proceed with IPOs. The expectation is the DC funding and other funding for that industry will continue to grow this year. So that's a good sign. But we're not going to bank strictly on the Life Science candidate for that building.

Last question. What is the impact of expensing options in '05 and also '06?

Actually nothing. We have just trailed out of I think we have, we haven't granted any office to management since 1988, and we have just I think the trailing cost on some very small directors' options. Last year the directors converted their compensation plan to a restricted stock plan. So it is, you could use zero.

Okay, thank you.

Ross Nussbaum, Banc of America Securities.

It is John Kim with Ross. I just wanted to clarify your TI costs. This amount that you shown is, you are committed and not spent costs on these leases?

Yes.

Also regarding your Life Sciences redevelopment, you will begin expensing interest this quarter?

Yes.

And what interest rate should we be assuming in our models?

Around 6 percent.

John, given the appetite for the Commonwealth portfolio are you considering potentially increasing your disposition plans for the year?

Well, we have a number of discussions going on at any given time. And we will just look at it as we always do, asset by asset and market by market. But we always have our eyes open and our ears to the ground. It has been I think the policy of the Company, and I think we've done this pretty well that anything that is nonstrategic or we feel doesn't have upside, and if it is particularly if it is older, we will spin out, and that will continue to be our policy.

Okay, and I know it's still early in the year but can you share with us what you see as some of the different characteristics of your new comp plan in '06?

John, we can't comment on that because those discussions haven't commenced yet. We just don't know.

Okay. Thank you.

James Sullivan of Greenstreet Advisers.

Just a follow-up on 909 Sepulveda, given what has happened in El Segundo since you started that project, the rental rates are either lower and given the extended lease up time versus your pro forma, what are the economics of that transaction? I just think it is noteworthy given its size relative to the size of your portfolio. Are you going to end up getting to your pro forma because of lower interest rates, or are you going to end up not quite making it?

Jim, my guess is -- I didn't look at those numbers carefully yet this month but my guess is we will be behind our pro forma and that the mitigating factor will be exactly interest rates. Obviously post 2000, post 9/11 that whole market as you know well essentially atomized or vaporized for a period of time and it remains as we have said our weakest market. So obviously if we had it to do over again we wouldn't have started what we did when we did. That is the one place where the market has moved strongly against us.

What if I asked it a different way? Given lower cap rates generally speaking, is that building ultimately going to be worth more or less than your total investment?

I think ultimately, I think they both be worth at or more (inaudible) today beauty is in the eye of the beholder for buildings that are not leased in this office market, Southern California. But I think we would have good confidence that it will be worth what we have in it. Beyond that I think it's hard to say. But if your central point is that those projects, those two projects companions, have not turned out as well as we would expect that is absolutely accurate. That is the case.

The point I am trying to get to is it worth more or less than the development jobs? Did you create any value or not?

We have not as of now created value, no.

Okay. You shared some broker's enthusiasm for the San Diego market and the prospects for rental rate growth. I think you said 11 percent, do you share that enthusiasm?

Jim, this is John speaking. I don't want to circle 11 percent. I think that as I said that brokers have varying -- I've seen everything from 5 to 10 plus percent -- it was the Torto Wheaton survey that said on average they were looking at San Diego at 11 percent. I don't think that is going to hit every market equally, but we do think that we will see strong single-digit performance in '05, and we may very well see double-digit performance in '05 and '06. That would be a happy surprise. We are not banking on it, but we do think that as there are certain markets obviously that are going to do better than others. We think the I-15 market will do well. We think Delmar will continue to do very well. UTC we think the rents will move up there in the true Class A buildings, and we think Sorrento Mesa will see some substantial rental improvement in particularly in the high-quality, two-story product and ultimately in the true Class A, true Class A product.

I assume you are talking about gross rents, correct?

Well, the rents in San Diego were quoted differently as I know you know. In the two-story pie they are recorded on the triple net basis, and on the Class A space they are typically quoted on a modified gross basis. That would be plus utility. So if the rental rate for example was 3 dollars, that would be 3 dollars plus utilities and utilities are anywhere from 15 to 20 cents a square foot more. So to get to a full-service rate taking that as an example the 3 would become 3.15 to 3.20 full-service growth. And I am just looking at the adjustment on the way that the rents are quoted in each case.

And if I were to think about net effective rents, gross rents, net rents modified rents, etc. but less releasing costs, presumably releasing costs are coming down too so the percentage growth of net effective rents would be even higher, is that the right way to think about it?

I think it is. Obviously we are talking in generalities; every building has its own peculiarities. (ph) As an example in the Sabre Springs project where we're moving the rents up pretty substantially, that building was leased at 250, roughly 250 a couple years ago. It has 10 percent vacancy; we're moving those rents up into early threes and we think those rents within a couple of years are in the mid threes on a plus-utilities basis. With pretty much the same or lower level of TIs and over time the deals that were done in that building a few years ago that have two, three months or whatever of free rent. We think that is going to go by the wayside here this year.

Okay, and then finally with respect to the comp program, (indiscernible) seem to express some frustration in how much time you have had to spend explaining that to people, couldn't you guys maybe cut off a lot of the questioning if you had just filed an 8-K that explained the program?

I am not all convinced of that. I know you and I just have to agree to disagree on this one, but no, I'm not because the main time that we spent talking about this just explaining the modeling and how it works, and you will just have to accept my assertion that to file an 8-K we would literally have had to put a computer model in it. We've summarized it here simplistically, but regrettably the way the plan works it is literally a computer model. And we have summarized that so you get the substance of it, but writing it just wouldn't -- we couldn't figure out a way to easily write it, so that is why we have done what we have done.

And the conversations that you have with people are people more frustrated with the volatility in the accounting and the modeling, or are they frustrated with the magnitude of it?

Well, we are frustrated in generally the inquiries we get are just walking people through the numbers. We are frustrated in spending all the time on it, but I would say virtually all of the questions we get are just walk us through the numbers.

Okay. Thanks.

(OPERATOR INSTRUCTIONS) Frank Greywitt of KeyBanc McDonald.

My question may have been answered, but given the $4.72 run up on your stock price December 31st over September 30th, I am estimating, I was estimating maybe a $4.5 to $6 million increase in G&A over the third quarter. Can you give some explanation as to why that was not the case?

The way this plan works, this is a good example of the question that we regrettably have to spend time on. The way the plan works as the closer we get to its expiration, the more the amplitude of the volatility. Last year if I recall right rule of thumb a dollar increase in the stock price translated to 3 cents a share. And I would have to go back and run through the math in detail. We could certainly off-line compare what happened versus your estimates and try and go through them and figure out why it was different. I just don't off the top of my head have the answer. We would have to go back individually I think and compare your numbers versus ours.

That sounds good. As far as there has been no change in accruals, though, due to the comp plan, correct, and you don't expect to do so?

We just mark to market at the end of each reporting period as we did at the end of the last quarter, fourth quarter for 2004. So too we will do for each quarter this year until the end of the year we're finally done with it.

Okay, and I guess trying to take another shot at it, when you look out in '06 right now your G&A is 15 percent of revenues, and before the plan it was around 6 percent of revenues. Where do you think a reasonable run rate would be kind of going into '06, '07, where that would be?

I wish I could. I just really can't comment on that other than to say just simply because we are not the decision-makers on that, but obviously the board and the comp committee are. But I think what we would reasonably expect is that this plan will expire and we will go back to something much more customary than and much more akin to something historical but we'll have to report back as we learn ourselves.

Thank you.

There are no further questions. I will turn the call back to Mr. Moran for any closing remarks.

Thank you all very much for joining us today, thank you for your interest in KRC. Have a good day.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.