Kilroy Realty Corp (KRC) 2006 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth quarter 2006 Kilroy Realty Corporation earnings conference call. My name is Danielle, and I will be your coordinator for today. [OPERATOR INSTRUCTIONS]. I would now like to turn the presentation over to your host for today's call, Mr. Richard Moran, Vice President and CFO. Please proceed, sir.

Thank you very much, and good morning, everyone. Thanks for joining us. With me today are John Kilroy, our CEO, Jeff Hawken, our COO; Tyler Rose, our Treasurer, and Heidi Roth, 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 regarding the forward-looking information in this call and in the supplemental. This call is being Webcast live on our Web site and will be replay for the next ten days both by phone and over the internet. Our press release and supplemental package have been filed on our form 8-K with the SEC and are both available on our Web site. We released our fourth quarter and year-end financial results early this morning. FFO was $0.79 a share for the quarter and $3.48 for the year. John will start the call with an overview of the quarter and the year and then review our key markets. I'll add financial highlights and our 2007 earnings guidance and then we'll be happy to take your questions.

Thanks, Dick. Hello, everyone. Thanks for joining us. 2006 was an excellent year for commercial real estate in southern California and we took full advantage of the strong demand and opportunities in the market. Economic growth was steady and broad-based, touching most geographic submarkets and industry sectors. Statewide, California added more than 170,000 net new jobs in 2006, keeping state and regional unemployment rates at historic lows. That job growth, along with rising optimism in many of our state's most important business sectors significantly boosted demand for existing and to be built space. Vacancy rates shrank across southern California and rents moved up, in some cases at double digit rates. I will provide more detailed market information a little later.

Meanwhile, significant liquidity in the financial markets and a rising appetite for real estate assets both by investors and users ensured strong valuations for office and industrial properties. Yet new construction remained muted, certainly when compared to earlier real estate cycles, but also relative to ongoing growth in demand.KRC was prepared for these market conditions and we capitalized in a number of ways. As I detailed in calls throughout 2006, we remain tightly focused on an effective leasing program while driving growth largely through new development. For the year, new and renewing leases commits on more than 1.5 million square feet of space in our stabilized portfolio, with GAAP rents up over 12%. Throughout 2006 occupancy in our stabilized portfolio hovered around frictional levels, ending the year just under 96%. Some of the most significant leases we signed were in the El Segundo market where we signed new details with Mattel, DirecTV, and Boeing amongst others, totaling more than 750,000 square feet.

In addition, in December, we stabilized another 77,000 square foot office building, moving the 100%-leased project from our development program to our stabilized portfolio. It was a particularly strong year for development at KRC, where we executed over 500,000 square feet of development leases in 2006 and now have 1.2 million square feet of new space under construction. This includes the most recent addition to our under construction program, a new two-story, 56,000 square foot office building within our master-planned Sorrento Gateway campus located along the 805 freeway in the submarket of Sorrento Mesa. We broke ground in December and expect to deliver the completed property late this year for a total estimated investment of approximately $22 million. Sorrento Gateway currently is home to four buildings totaling 310,000 square feet that are all 100% leased. The total estimated investment represented by our under construction, development and redevelopment projects is approximately $377 million and 82% of it is preleased to strong credits. It will begin to deliver later this year.

Beyond development, we continued to take advantage of rising asset valuations by selling two projects in 2006 for $62 million that generated a book gain of $31 million. In addition to these transactions, we also received a $9 million lease termination fee prior to selling the asset. We also kept our eye on the future and are pleased to announce that just last month we made two strategic additions to our development pipeline and are positioned to close a third later this month. In mid-January, we acquired an excellent two-building redevelopment opportunity from a large corporate owner with whom we have a good relationship. The property is located along the high demand I-15 corridor just south of our Kilroy Sabre Springs project. The purchase price was $24.7 million, and we expect to spend about $9 million to redevelop these two to-be leased buildings.

In addition, we closed last week on a $28 million acquisition of 10.5 acres of land that will comprise the third phase of our Santa Fe Summit project, which is on the eastern edge of the Del Mar market along the 56 corridor. With 466,000 square feet under construction for Intuit on Phase 1 and 340,000 square feet entitled for office on Phase II, at buildout our entire three-phase Santa Fe Summit project will now encompass more than 1 million square feet of state of the art office and support retail space in perhaps the most desirable location in San Diego County.

Finally, as we have previously discussed, we expect to close in our Carlsbad Oaks acquisition this month. This is a 24-acre land parcel near the Palo Mara airport in north San Diego county submarket of Carlsbad. To recap, our future development pipeline now includes fully entitled properties located in highly attractive San Diego submarkets, including Sorrento Mesa, the I-15 corridor, and the 56 corridor with a construction potential to exceed 2 million square feet of office space at a total investment ranging between 700 and $1 billion, depending on the density of future buildout.

Now let's finish with a quick tour of our individual submarket conditions. KRC remains the leading player in San Diego's commercial real estate markets where fundamentals remain strong. Central San Diego, the location of all our properties in active development, is currently registering active demand for office space of approximately 7 million square feet. In terms of new supply in San Diego, there is about 1.9 million square feet under construction in our core markets, 1.0 million of which is our 82% preleased development. While we continue to monitor our competition carefully, our markets continue to perform well with over 1.6 million square feet of net absorption last year. In Del Mar, possibly the best office market in southern California --

Your other line --

Hello. In Del Mar, possibly the best office market in Southern California, KRC is the dominant office landlord with approximately a one-third market share and a two-thirds market share of top tier Class-A product. Current direct vacancy here is approximately 4.7% and total vacancy is 13%. Our stabilized properties in Del Mar are 100% occupied. South of Del Mar, the submarket of Sorrento Mesa, KRC competes in two- and three-story products. Direct vacancy for this product type is currently 5.1%, and total vacancy is 8.1%. Our stabilized properties there total approximately 1.5 million square feet and are currently 97% occupied. In the UTC/La Jolla submarket, just south of Sorrento Mesa, we also compete in the two-story product type, current direct vacancy is about 4.7% and total vacancy about 8.7%. Our UTC properties total approximately 430,000 square feet and are 100% occupied.

On the I-15 corridor, KRC now owns approximately 750,000 square feet of stabilized office space. The two-story product type here has a current direct vacancy rate of 2.9% and total vacancy of 4.6%. And the class A product type, direct vacancy is 11%, and total vacancy, 14.5%. Our stabilized properties here are 99% occupied. Moving up the coast to Orange County, KRC's 3.7 million square feet of industrial properties are 96% occupied and that includes the vacancy at our 157,000 square foot industrial property that we are currently rezoning to residential. And as I reported on prior calls, we continue to make progress on this conversion and expect to receive the necessary approvals by midyear.

Further north, at Kilroy Airport Center Long Beach, our seven-building office campus immediately adjacent to the Long Beach Airport is currently 91% occupied. Demand in this market remains steady with Class A direct vacancy of 5% and total vacancy of 5.8%. Now let's move on to El Segundo. As I mentioned earlier, we've made significant leasing progress here. Our stabilized products in the submarket are currently 92% occupied. Direct vacancy in El Segundo Class-A market is now 17.5% and total vacancy at 18.2%. This market continues to improve as the surrounding submarkets tighten. The West Los Angeles submarket is one of the areas that has shown dramatic improvement from movies to music to gaming, entertainment-related businesses are highly concentrated here and they've driven direct vacancy in West L.A. down to 6.1% with total vacancy at 6.8%. Our properties in the market totaling 680,000 square feet are 97% occupied.

Our final Los Angeles submarket is along the 101 corridor running through northern Los Angeles and southern Ventura counties. This market demonstrates perennial strength, attracting a range of industries with its location so convenient to affluent northwest L.A. suburbs. direct vacancy here is currently 5.8%, and total vacancy of 8.6%. Our properties here are 97% occupied. Now let me give you an update on our Boeing lease in Seattle. Boeing currently occupies 211,000 square feet or about 40% of our Sea-Tac project near the airport. Boeing has now exercised its three-year option to stay in its 211,000 square feet through the end of 2010.

That's an update on our activities and markets. Let me sum up by simply repeating that we are very well-positioned to continue to create value through development and redevelopment in 2007. It is our ongoing belief that disciplined, high quality development in the most attractive submarkets of southern California is one of our key growth strategies and that's our consistent focus has been since our IPO just ten years ago. We are obviously very pleased with our key strategic move to enter the Northern San Diego markets in 1997 and now ten years later, approximately 60% of our current NOI comes from properties we developed in San Diego, L.A., and Orange Counties since going public. As always, we appreciate your interest and support.

Now Dick will cover the financial results. Dick?

Thank you very much, John. FFO in the fourth quarter was $0.79 a share and $3.48 for the year. The fourth quarter results included $0.03 a share of unusual cam-related income and lease termination fees. Occupancy in our stabilized portfolio at year end was 95.8% compared with 96.2% in the third quarter and 95% at the end of the year 2005. Same-store NOI increased during the fourth quarter both on a GAAP and a cash basis. GAAP NOI increased 1.6% and cash NOI was up 2.5%. For the full year, GAAP NOI increased 2.6% and cash NOI was up 4.1%. Higher average occupancies and higher rental rates both contributed to our NOI growth. GAAP rents increased 13.6%, and cash rents were up 5.9% in the fourth quarter. For the year, GAAP rents increased 12.3% and cash rents were up 3.0%. We currently estimate that our overall portfolio rent levels are about 5 to 10% below market.

Capital expenditures in the fourth quarter were $7.0 million up from $4.2 million in the third quarter. The fourth quarter number includes about $2 million in capital improvement and upgrade projects in our Los Angeles portfolio. For the year, capital expenditures totalled $18.8 million, our 2006 FAD payout ratio was 76%. In 2006, we continued our long-standing disposition in capital recycling programs and sold two buildings totaling 437,000 square feet for $62 million. The book gain was $31 million. With all the leasing we did last year, we began a major acceleration of our development program. As a result, we now have a very big construction program underway. We expect the acceleration of our development program to make a significant contribution to our earnings growth beginning in 2008.

During the fourth quarter last year, we stabilized one project and added another to our active development program. In December, Accredited Home Lenders took occupancy of its third building in our Innovation Corporate Center complex in Rancho Bernardo. Our total investment in that building is $21 million. We also began construction in December on a new 56,000 square foot office building at Sorrento Gateway in the Sorrento Mesa submarket. Our total investment is projected to be $22 million. We now have about $377 million of development and redevelopment underway, including six discrete projects totaling nine office buildings and just over 1.2 million square feet. $178 million has been spent to date on these projects, which are 82% preleased. Subsequent to the end of the year, we closed two acquisitions in January, totaling about $53 million, including the $28 million Santa Fe Summit Phase III land acquisition and the $24.7 million redevelopment project that John mentioned earlier. In addition we also completed the sale of two El Segundo projects in January. This included an older 62,000 square foot office building and a small 6,000 foot industrial property. The sale proceeds were $14.4 million, and the book gain was approximately $10 million.

Now let me finish with 2007 FFO guidance. We have a couple of key market factors that will have an unusual influence on our year-over-year comparisons. First, let me start with a few comments where we stand on our compensation programs. Our 2007 executive compensation program has just been approved. Other than salaries, all of the 2007 program is performance-based. The total amounts that can be earned under the portion of the 2007 program applicable to the top three people will be less than 2006, most likely by roughly 4 to $7 million. The 2007 program also has a hard cap so the maximum amounts of earned compensation this year from the top three of us will be at least $4.3 million less than in 2006. Also, our compensation committee has conceptually approved adding selected additional members of our senior management team to the 2007 executive compensation program, and we hope to have that completed in the near term. As an aside, nonexecutive senior management compensation was up $2.6 million in 2006 over 2005, and we're budgeted 2007 earned senior management compensation as the same level as 2006 actuals. That covers, at a summary level, the amounts that can be earned under the 2007 program.

Since most of our executive and senior management compensation is paid in equity that gets vested over time, the way it's amortized on our income statement under FAS 123-R gets a bit complex given the unusual timing of when our 2006 and 2007 programs were adopted. You may recall that the approval of our 2006 compensation plan was completed at the end of the third quarter last year. Given that, based on their acquired accounting treatment for the 2006 plan, our 2007 G&A will essentially carry a double hit on reported earnings. Stated another way, our reported earnings this year will reflect anomalies since the 2006 plan approval was completed late last year and the 2007 plan was completed early this year. Under FAS 123R, equity plan amortization doesn't start until a program is definitively approved.

So as we outlined last year, our 2006 reported results didn't bear any amortization costs for the equity portion of the 2006 executive compensation program until it was definitively approved at the end of the third quarter last year. So in effect, our 2007 G&A costs will include most of the first-year costs of both the 2006 and 2007 executive compensation plans. And since both are payable mostly in equity, the cost amortization of the plan is accelerated and quite front loaded. Please bear with me for a moment here because the explanation of the year-over-year earnings affect of the '06 and '07 compensation plans is lumpy and a bit complicated.

Last year, since our 2006 program was expensed only in the fourth quarter, the related amortization costs was $0.09 a share for both the quarter and the year. This year, the accelerated amortization cost of that same 2006 program will be $0.28 a share. In addition, the budgeted first-year amortization cost of our 2007 program is $0.12 a share. So for 2007, our guidance includes amortization costs related to the 2006 and 2007 programs of $0.40 a share compared with our actual costs of $0.09 a share last year. So that's a one-time year-over-year projected increase of $0.31 a share for amortization of the 2006 and 2007 equity programs.

The second key factor that will have an unusual affect on our year-over-year earnings comparisons is lease termination fees. Last year we had $0.35 a share in lease termination fees, including $0.29 from Qwest on the Orange County Industrial Project we sold. We don't currently expect any significant 2007 termination fees, so that's a projected $0.35 expected reduction in our reported earnings that was incorporated into our initial 2007 guidance. So taken together, the projected $0.35 decrease in our lease termination fees and the $0.31 increase in our stock amortization costs will cut our reported earnings by $0.66 a share compared with last year. Numerically, the other assumptions we've used in determining our 2007 guidance include average occupancy of 95%, straight line rents of $5.4 million, second generation CapEx of $23 million, capitalized interest of $23 million, development starts of $150 million, development deliveries of $364 million, weighted heavily to the fourth quarter,dispositions of $50 million, including the $14.5 million El Segundo sale that was completed in January, and no acquisitions other than the January land and building acquisitions and the Carlsbad land acquisition that we mentioned earlier. Taking all those assumptions together, the translation to our initial 2007 FFO guidance of $2.87 to $3.03 a share, with a midpoint $2.95 a share. That's the latest news from here and now we'll be happy to take your questions. Operator?

Thank you, sir. [OPERATOR INSTRUCTIONS] Your first question will come from the line of Jonathan Litt with Citigroup.Please proceed.

It's actually Michael Bilerman Jon Litt is here as well. Maybe you can go over the comp plan for 2007. I think you said it's completely performance-based, so there's no impact for any development starts or anything else. It's completely tied to performance?

There is a -- most of the metrics are related to internal operating performance. In addition, there's a component related to shareholder return, absolute and relative both. And then there is a modest component that is related to performance over the development construction and leaseup periods of our development starts. There is, as a requirement for that small development piece that we have a certain minimum level of starts, which is fairly modest. So as to make sure that the external optics didn't create the assumption that we had any incentive to just start for the sake of starting. The way that gets earned is only upon the meeting of specified criteria related to construction and leasing.

And what's the max threshold for the complete cost of the plan?

The maximum amount?

That could be awarded, right.

Well, for the top three people, the absolutely maximum will be disclosed later this week, but it's roughly 20 to 30% in the range we expect lower than what was earned last year. The absolute maximum is $4.3 million less than last year.

And you're saying that that then gets reallocated to the other participants that are coming into the plan?

That's the substantiative affect, although the increase in the senior management compensation, as I mentioned, was $2.5 million last year and we have budgeted the same level including that increase for this year.

And you had talked last quarter, you had given very specific numbers for the impact of the '06 plan on '07, '08, and '09 numbers. I know that it sounds like the '06 plan impact on '07 has gone up from $0.25 to $0.28. Can you talk about why that changed as well as what the impact for '08 and '09 will be for the '06 and '07 plans?

I'm sorry. When we said $0.20 to $0.25, I think that was just our hurried estimate at the time. I think the $0.28 is, if I recall, the number correctly, is simply a more precise number. And we did have one more start at the end of the year that affected the way our program worked last year. I'm sorry, the second half of your question is, what?

What impact for the second half of the plan for '08 and '09? What impact for the second half of the plan for '08 and '09?

I don't think that we can -- I don't have the '09 numbers in front of me, but that $0.40 a share for the 2006 and 7 programs that I mentioned that will occur in '0 -- that will hit our income statement this year will fall to $0.25 next year in 2008. I don't have the '09 numbers in front of me.

Okay. And then in your prepared commentary, you talked about something about a $0.03 recovery, I just didn't pick it up.

We had some unusual timing differences in CAM income and a smaller part of it were related to lease termination fees in the fourth quarter that were positive for reported earnings, but unusual and we just thought it beared mentioning.

Okay.

I guess what I say on the compensation plan is that obviously our key strategy is driving development through growth, as John touched on. The unusual oddity of GAAP is that the way stock-based plans get costed out these days under FAS 123R is on a quite accelerated basis and so you have a bit of a -- it's correct under GAAP, but I would view it personally in my own opinion as a bit of a mismatch, because we cost out the incentive compensation related to our results on a very accelerated basis, and yet the earnings accretion naturally from the related development has a bit of a hockey stick affect. As I mentioned earlier, we will begin to see very large affects on our earnings of our 2006 leasing and 2007 construction in 2008.

And the last question, just on same-store NOI, what would cash same-store NOI have been this quarter if you adjust for the large bad debt recovery you had last year, as well as for lease termination fees?

I don't have that number in front of me, but it's not that significantly different.

Okay, thank you.

Your next question comes from the line of Lou Taylor with Deutsche Bank. Please proceed.

Thanks. Dick or Jeff, can you talk about just the TIs for the quarter and what drove them higher?

There was three transactions, mainly in Los Angeles that drove the TIs a little bit higher than normal. If you take that out, it was about on track.

But in terms of, was it more of a building mix, was it particular credit that you were trying to get, or unusual space, or longer leases, what was unique about these three deals?

One was in our property with Ryland Homes, another was in long beach, a little bit higher end properties as a comparison to the rest of our portfolio. I would just say, generally, it's the higher end part of the property.

Okay. On the 1031 sale proceeds that you had footnoted in the supplemental, do the acquisitions you announced, have you used that all, or is there any left?

We have used that all up now.

Lastly on the Evening Creek deal, what are your rough plans in terms of development, what kind of density can you get on that site?

Lou, this is John. We bought a two-building 104,000 square foot campus that's just -- there's one building between it and our Kilroy Sabre springs property there at the intersection of 56 and I-15. Buildings where are previously occupied and owned by Intel. They're tremendously well-located, they have all the amenities of our adjacent project. We need to go in and embellish what's there and improve it. The market's down in the 2.9% for that kind of product in that market. We think it's a terrific home run for us and they're buildings that we can either go, breaking them up to multitenants per floor or do a tenant per building or a tenant for the whole complex. We feel with what we're seeing in demand right now and a tour through that building since we closed escrow on it, we're very well-positioned.

All right. So it doesn't sound like you're going to tear the things down and redevelop and everything.

No, no. They're terrific buildings that just need to be repositioned. But the bones, the mechanical systems and so forth are in very good shape.

Okay, thank you.

You're welcome.

Your next question comes from the line of Ian Weissman with Merrill Lynch. Please proceed.

I was wondering if you could address the sequential drop in same-store NOI over the third quarter?

Well, the --

What was the driver? Was it the Pacific Corporate Center, vacancy loss there?

Yes. We had one lease in San Diego that vacated in the fourth quarter, which we've actually signed already and that's going to be back in occupancy in the first quarter. That was the key driver in occupancy.

Was that at Pacific Corporate Center?

Yes.

It was. And maybe you could also touch on, I think, Dick, in your guidance, you said that year-end occupancy was going to be at 95% versus we ended the year at 95.8%. Are you facing greater leasing challenges in your market because of vacancy, or is that going to be a redevelopment issue?

No. Obviously, we have the one project, Von Karman, that's empty and that's roughly 1% of our portfolio in a square footage basis, but in big round numbers, and we're holding that empty obviously for conscious reasons because we're rezoning it. But overall our as an amplification to what Tyler just said in answer to your last question, I think our experience over time in a multi-tenant office portfolio, it's difficult to each and every quarter hold occupancy even in a good market much above 95, except in exceptional conditions. In part, even in a great market when you're releasing, if space has been occupied for quite some time, then there are times you just need to go back in and core out the space. It can take six months or more sometimes just to redo space to get it to make the most money in the long-term. We look on a present value basis. We always try to make the right real estate decisions. So I think our take is that overall is it's difficult to maintain an average occupancy of much greater than 95% in a multi-tenant flow, even in a very good market. In our case, that 95 is net of roughly 1% of the Von Karman project also, I should mention.

And just to be clear, the 95% for 2007 is the average occupancy.

Okay. And maybe this is kind of relates to the occupancy question, maybe you can help reconcile this. On your Web site at 6260 Sequence Drive, the whole building is available for releasing, 130,000 feet. But in your fourth quarter number, it looks like that building was 100% leased. Is your assumption you're going to release that space, that's a sizable chunk of space to look at for 2007, is that including your 95%?

I think that's a case of the Web site not being updated. The actual numbers in the supplemental are accurate.

And just in reimbursements, if you could clarify, is your run rate going to be closer to what you reported in the third quarter? You said there was an uptick in the fourth quarter.

For 2007 in general?

Yes, just as a run rate.

Yes, that's relatively close.

All right, thank you.

Your next question comes from the line of John Guinee with Stifel Nicholas. Please proceed.

Good afternoon. Can you talk about your development product that you're delivering in '07 and '08 and what the I-5 is costing you to develop state of the art product and what the I-15 is costing and the difference between the two?

You're going to have to -- this is John Kilroy, I got a little lost. The difference between which and which?

Your total development product, your total development budget or cost on the I-5 corridor, where you're building a little bit better products, structured parking, et cetera, what that total development cost is relative to the I-15 corridor where you're building a more basic product?

Well, our products range in San Diego from midrise generally four to six-story product to -- which frequently have structured parking either in whole or part. The other end of the spectrum is two-story product that tends to be generally surface parked. So the differential in cost is both as a result of the different class of construction, because even a five-store building is considered high-rise and a difference between steel frame and concrete tiltup. And then, of course, the parking garages tend to increase costs significantly. To give you sort of a broad brush, if you delete land, new construction for class A, again, depending upon tenant approval allowances and so forth is, going to be somewhere in the neighborhood of high 300s to early 400s per square foot, plus land. Whereas the two-story product is going to be in the neighborhood of 225 to $240 per square foot in land. So you end up with a cost differential between those two product types, and yet, in many cases, as the Sorrento Mesa market being a case in point, the rentals are actually higher on a equivalent triple net basis for the two-story product type as they are for the Class A product type.

Great, thank you.

You're welcome.

Your next question comes from the line of Michael Knott with Green Street Advisors.

Can I just clarify the 2007 compensation plan? That's just the new annual plan, that's not a multi-year plan, is that correct?

Correct.

Any sense as to when and if a new multiyear plan might be in the offing?

We don't have anything beyond what has -- what we've talked about here this morning under consideration.

Okay. So we should expect to not have a new multiyear plan?

All I can say is we don't have anything under consideration. I'm always hesitant to speculate about the future what could and might happen, but we have nothing under consideration at this time.

Okay. Just going to Del Mar, it sounded like the total vacancy in Del Mar ticked up a couple of points versus last quarter. Can you comment on that?

Yes, Michael, this is John. The total vacancy, of course, includes a sublease, and that's up to 13 or so percent. I believe you'll see half of that evaporate within about the next 30 days based upon two transactions that are being signed. What's happened in that market is the lion's share -- well, the lion's share of the sublease spaces where there are a couple of buildings where the user was bought by bigger users, that space was put up for sublease. It's now being transacted for, and then there's a little bit higher vacancy rate in the older, still viewed as Class A, but I view it as nonstate of the art Class A that has the multitenant type buildings in the marketplace.

Okay. Also in Del Mar, can you just give your thoughts on the recent sales comp there? I think it was around $520 a foot, and what that means for your portfolio.

I think it means good things. There's going to be another comp that's going to be for a complex -- the buildings that you're mentioning are directly across the street to the east from some of our projects and is located in between on the north and south. Other Kilroy projects. That property traded with about 72% occupancy and the balance to be let. It went for a very low cap rate with a lot of leasing to do. There's another building that is in escrow that is a stone's throw from there. Not one of our buildings, it's multitenant. It's going to trade, I think at a higher cost per square foot, and I believe with even a lower yield. So all of that, obviously, has a significant bearing on the value of properties in that marketplace. And because we own the best properties and have a lion's share of the market, obviously it's good for Kilroy. I'm not going to quote what I think our properties are worth per square foot, but directionally, it's very positive.

Okay. Lastly on San Diego, can you just talk about the velocity of tenant interest and demand for your spec buildings there and the amount of tours and activity you're seeing?

Yes. It's actually quite good. You've heard me say over the last couple of years in conference calls that at any given time there's been anywhere from 6 to 8 million square foot of demand. There's 7 million square feet of demand and that's in that central San Diego area where we have all our buildings and properties. We're seeing very strong demand from the service sector, financial, legal, software, electronics, telecom, corporate headquarters, consumer products, even a life science area, which has been pretty flat to negative over the last three years is showing signs of increased demand. So it's broad-based, it's broad-based throughout different industries. We're seeing that pretty much all of those with the exception of life science in every market that we have property down there.

With regard to the tour question, we have a lot of tours going on through our various properties, both those under construction as well as with regard to each of our future development sites in San Diego. There are a couple of very big users that are not at this point part of that 7 million square feet that we're having early stage discussions with. So I feel it's -- I feel we're in a very good spot and hopefully that will translate into a very good year on the development front for us.

My last question. Can you just talk about the El Segundo properties and your prospects for leasing the vacant space there in 2007? It looks like there's about, call it 110,000 feet to be leased in your portfolio there?

Is that correct on square footage, Jeff? Yes, that is correct. Well, we're at 92%, and that's good. I'm pretty confident we're going to drive that up, and I would hope to be in the mid-90s through this year. We've got our work cut out for us to get there, but I think the momentum is in place. Our properties are very well located and they're good properties, modern.

There's about 700,000 square feet of current demand in that market. If you sort of break down the vacancy in El Segundo, about 54% of the Class A vacancy is in one project, not ours. That sort of has an ongoing problem with regard to getting its occupancy up. So I'm -- we're seeing broad-based demand. I feel reasonably good about El Segundo. I'm not going to say it's going to be ultra-robust like some of the other markets, but it's certainly a far improvement from where it's been over the last few years.

Thank you.

You're welcome.

Your next question will come from the line of Ross Nussbaum with Banc of America Securities. Please proceed.

Hi, guys. Good afternoon. A question first, on the tax front, I was a little surprised with the 7% tax increase for the full year '06. I'm just curious what you've budgeted in for 2007?

Are you talking property taxes?

Yes.

I think that that that's just related to bringing new development on stream, just under prop 13. The only thing that happens is you get 2% tax increases.

I thought I was looking at the same store number of 6.9%.

In 2005, we had some property tax refunds for some property tax appeals at some of our properties, so the year-over-year comparison is skewed.

Got it. That's why -- with prop 13, I just didn't understand that number.

Yes.

Dick, you had also commented on a statement that your current rents were about 5 to 10% below market, I'm assuming that's on a cash basis?

Yes.

What are you assuming just generally for your markets in terms of rent growth during the course of 2007 given when and where the market vacancy rates are?

Well, we're, we obviously have to rely upon the brokers, and broadly speaking across all of our markets, it ranges from 5 to 10% plus. Obviously, we tend to see the higher end of that range in markets like Del Mar and the I-15/56. Sorrento Mesa, we think we're going to see somewhere in the neighborhood of 8% to 10%. Here on the west side, we think we'll see some fairly significant jumps. It's demand-based. If you look at it, two markets that are terrific are central San Diego, where we have our four predominant submarkets and of course, west L.A. If we look at the demand which is driving the rent, west side market has about 42 million square feet in market size and about about 2.2 million square feet of current demand. So about 5%.

If you look at the demand as a percentage of market size, it's about 5%. If you look at that Del Mar/Sorrento Mesa/UTC/I-15 corridor where about 44 million square feet, there's about 3.5 million square feet just in those markets or about 8% of the market size. I think those five markets, those four in San Diego and that in the west side is where you're going to see the higher end and it remains to be seen. In some of these markets, there could be quite a bit more. We're pushing rental rates pretty significantly down in San Diego.

Okay. Finally, Dick, just an accounting question on the comp plan again. I understand you walk through the impact on the G&A line. But on your share count, when are those shares coming in from the '06 and '07 plan? Is it the treasury stock method with respect to part of the plan. I'm missing part of the timing quarterly?

I'm let Heidi answer that.

The shares will be added to the share count as the time-based vesting lapses.

It's specifically time to the vesting?

Yes.

Not to any of the performance hurdles?

Well after the performance hurdles are met and the awards are earned, then it's based on the vesting.

Okay. So if --

Over the next two to three or four years depending on the plan.

I guess where I was going, since part of it is based on share price performance and part of it is based on on share price performance and part of it is based on internal performance, it's not absolutely set in stone that it's going to be a third a third a third, but as your share price goes up, we could see more of those shares coming in on a --

Well, we wouldn't have -- we would revise our estimates during the year, but I don't think you'll see terribly much volatility because we've tried and during this year, because what we've tried to do is have a program that minimizes the volatility, recognizing that as our performance changes, the compensation measurements will change. But I think -- to state another way what Heidi said is that the shares don't -- the way our plan works, we don't get awarded anything until the end of this year. We earn it during this year and then at the end of this year, we get awarded the stock. And that's when the stock is formally granted to us. During this year, we're just costing an estimated portion out.

That's where I was going. So the shares from the '06 plan would hit either in Q4 '06 or Q1 '07 -- or, sorry --

Yes, and I believe we have a 12 -- just trying make everybody's life easy, we're in the midst of a transition to 12/31 each year vesting dates. That will take several years to form all of that. I would add that when you study it, the development portion component of our plan each year mentioned earlier is not a very large in dollar terms or proportion part of the program. It does have quite a long daily to it. So that will stretch out quite a long time, depending on leasing and construction performance, because it's all key to completion of those. So it could take several years.

Okay, that's helpful. Thank you.

[OPERATOR INSTRUCTIONS] Your next question comes from the line of Sri Nagarajan with RBC Capital Markets. Please proceed.

Thanks, most of my questions have been answered. John, in your comments, you mentioned about rezoning some of your industrial property to residential. Given the overall housing softness, what are you seeing in your submarkets with respect to residential? And if so, are you changing your disposition strategy here or accelerating or decelerating the disposition to residential?

The property I mentioned in our Von Karman building down in Irvine and we're seeing tremendous interest from both the apartment and condo folks for the type of product that would go on that particular site. So we think we're in good shape once we get our zoning to be able to entertain offers in the ranges that folks are talking to us about. I think it will be an attractive transaction. It remains to be seen whether we accomplish that, obviously. But all indications are is that there's actually been an upturn for that particular type of product. Remember, this is four-story product. It is not the Class A high-rise type of condo that has gotten so soft in that Irvine market.

In terms of your potential other parts of your portfolio having some potential for such conversions, would you care to expand or comment on that?

As I've commented on in earlier calls, we look at all of our properties and specifically with regard to the 3.7 million square feet of industrial we have in Orange County, we think there are going to be significant number of opportunities over the next several years to convert to higher use. Whether that's converting to Class A office, whether it's converting to something in residential, whether it's converting to some other kind of component of mixed use remains to be seen because there are different properties in different locations with different possibilities. In some case, it will simply be being able to densify the existing type of uses, where we're entitled to build more than the current tenant leases, but we need to unencumber it by the existing lease situation. I think we've got a very good opportunity to manufacture value, specifically in that Orange County portfolio; I just can't give you specific times.

Sure. My second and last question, in response to a previous question I think you'd mentioned about the volatility of the new comp plan being lower. In fact, and obviously the new development comp plan of it also being lower. Could you just break it down for the investors as to how much sense would it affect if it's as simplistic as that and per dollar of stock price increased, how much would your G&A go up by?

It actually doesn't work that way, if I understand your question correctly. We have to -- there's a portion of the plan and it's not -- since that is multifaceted plan, it's not tremendously significant that's related to absolute performance and another segment that's related to relative performance and in each instance, we either make them or we don't. And so at last -- it's binary. And so there isn't -- we can make -- there's a segment of the plan that is capped that relates to each of those two different segments, and if we hit the thresholds, we make it, if we don't hit it, we fail to earn that.

Okay, great. Thanks a lot.

Your next question comes from the line of Dave AuBuchon with AG Edwards. Please proceed.

Dick, on the G&A plan in 2007F you reach the thresholds on the stock plan, what is the value as percentage of the overall plan for internal metrics versus the stock performance? Assuming, of course --

The internal metrics are a much larger portion. Because they are driven -- there's obviously a bunch of operating performance. It's a little difficult to answer -- this is sort of one of those things that it will be actually easier when you see all the numbers laid out when we file our required disclosures on it, but the amount that's related to stock price performance is in one of the plans and it's not tremendously large as a component because we have a very fairly significant portion of the current year compensation that's related to just internal metrics of operating performance. The kinds that we use in evaluating the business. There's another segment of the program that part of it relates to the development performances I've talked about, and part of it relates to share price performance.

And this is being filed later this week, you said?

Correct.

Okay. On the sale of the industrial building, is that included in your $60 million disposition guidance? The industrial building in Orange County, sorry?

Yes, the one we did at the beginning of this year, correct.

No, the Von Karman?

No, that's not in our $50 million of guidance, no.

John, you mentioned that the Santa Fe Summit site in total once you have built it entirely out will be 1 million square feet plus, so doing the math it looks like the third phase is pretty equivalent to the other first two in terms of size of buildings. So assuming it's 350,000 square feet or so buildable square footage, it looks like your land cost will be $80 a square foot at that size, is that accurate?

Order of magnitude, I think that's right, but we can give you that, I don't have that number right in front of me.

Okay, assuming, given your other comments about hard cost, it looks like total project costs at Phase III of Santa Fe Summit will be close to $500 a square foot. Can you comment on market rents today in that area?

Yes. The rents that we are working on Santa Fe are Kilroy Sabre Spring, which is a very well-located building at I-15 and 56, but I would say not as good a site as Santa Fe Summit is in the 420, 440 triple net range. And I think we're going to be -- our pro forma is less than that with regard to Santa Fe Summit, but I gave you those construction cost numbers, because I'm working ahead towards what I think they're going to be. They are a little different in each project, depending upon not only the amount of structured parking one has, but also with regard to your city extractions and your entitlements.

What Santa Fe Summit has, as many of our properties do that's pretty attractive, is we don't have any unknowns with the city, and we have favorable off-site, on-site costs. And our off-site costs are already paid. In Phase 3 of Santa Fe Summit, in comparison with the first two phases, the first is Intuit, the second one which is designed but not yet leased, the third phase will have a significant component of surface parking. And to give you an idea, structured parking, excluding land costs is about $14,000 per space. Subterranean parking is about $40,000 a space. So anytime you have surface parking, you're in lower than $5,000 per space.

Okay. My last question is related to the Kilroy Center Rancho Bernardo. Have you come to any conclusions regarding what type of product you're going to build at that site?

Let's just say we're having a discussion with somebody that has an interest in quite a bit of it and that would translate to somewhere in the neighborhood of substantially more than 700,000 square feet. Can't tell you whether we're going to make that deal or not. I think our thinking -- I mean, our thinking right now, we've always said we're going to be somewhere in the neighborhood of 800,000 to 1 million square feet and I don't want to get tied down, because you always want to develop more if it makes sense. On the other hand, if somebody comes along and wants a campus and they want 800,000 feet and that's the extent to which they want it built, than we preserve the right, hopefully, to develop the rest later, life after that tenant, but it's the reason we have a range there. I just don't feel comfortable until we've signed a deal or two getting -- shrinking that or expanding it beyond those ranges.

Can you -- do you think you can get the rent that is you're getting at Santa Fe Summit, or what you think you can get at Santa Fe Summit?

I think -- we have a very favorable land basis in Rancho Bernardo and I don't think we'll get the rents we have at Santa Fe Summit, but I think we'll get rents that produce similar yields.

Okay, thanks.

You're welcome.

And you have a follow-up question from the line of Jonathan Litt with Citigroup. Please proceed. Mr. Litt, you may proceed.

Thank you. Just a quick follow-up. On the lease term fees, Dick, you said that effectively there's no lease term fees at all in 2007 guidance?

Correct.

Okay. And then, the quarterly impact of those $0.40 on the '07 -- '06 and '07 comp plans, is it straight lined across the quarter, or is there some volatility?

No, that would be straight line. There's no volatility there.

Okay. And what's the estimate for G&A outside of the comp plan?

Describe our total, Heidi? Our total estimate?

The total estimate for G&A expense for 2007 is $33 million, just north of $33 million.

And that's inclusive of the $0.40?

Yes.

Lastly, John, you talked about the Seattle Boeing extending, taking their option on the three years. What does that do to your thought process on potentially monetizing the asset?

Well, I'm not going to get pinned down on that because we are -- we have a lot of things going on in our portfolio. It obviously would strengthen -- if we wanted to sell it, it would strengthen the value. But I think that's as far as I'm going to go at this point.

Okay, thank you.

You're welcome.

There are no more questions in the queue. I would now like to turn the call back to Mr. Richard Moran for closing remarks.

Thank you all for joining us today. We appreciate your interest in KRC as always. Thank you.

Ladies and gentlemen, this concludes your presentation. You may now disconnect, and have a great day.