Kilroy Realty Corp (KRC) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Kilroy Realty Corporation second-quarter 2010 earnings conference call. My name is Onika and I will be your operator for today. At this time all participants are in listen-only mode. We will have a question and answer session toward the end of the conference. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. At this time, I would now like to turn the call over to Mr. Tyler Rose, Chief Financial Officer. Please Proceed.

Good morning, everyone. Thank you for joining us. With me today are John Kilroy, our CEO, Jeff Hawken, our COO, Heidi Roth, our Controller, and Michelle Ngo, our Treasurer. 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 telecast live on our website and will be available for replay for the next ten days, both by phone and over the internet. Our press release and supplemental package have been filed on a Form 8-K with the SEC, and both are also available on our website. John will start the call with an overview of the quarter and our key markets. I will add financial highlights and update an earning guidance for 2010, and then we will be happy to take your questions. John?

Thanks, Tyler. Hello, everyone, and thanks for joining us today. A lot has happened at KRC since our last call. We added two more acquisitions to the two we announced in April, and closed four transactions in the second quarter, for a total purchase price of approximately $411 million. The four new projects increased the size of our stabilized portfolio by 1.3 million square feet. In the capital markets, we successfully placed a $250 million debt offering of ten-year notes and tendered for $150 million of our outstanding 2012 exchangeable notes. We are also nearing completion on a new $500 million revolving bank facility.

Our leasing momentum continued, with results that mirrored the first quarter. We signed new or renewing leases on about 332,000 square feet of space during the quarter, and year-to-date, we've now signed leases on more than 800,000 square feet.

In addition, we have a large pipeline of Letters of Intent that currently totals 616,000 square feet, approximately half of these LOIs are related to office leases and one-third are related to potential new leases on currently vacant space. The average deal size is approximately 17,000 square feet. As a result of our leasing success over the past three quarters, occupancy in our stabilized portfolio increased 85.1%, up from 82.8% at the end of the first quarter. We are now 89% leased.

I should also note that market conditions remain mixed. Leasing is still competitive. Tenants continue to negotiate aggressively on leases, and in decision making, time frames remain extended. However, as we said last quarter, we are seeing stabilization in most submarkets. San Diego experienced positive absorption for the second consecutive quarter, while many of the vacancy rates in our other submarkets were basically flat compared to last quarter.

Given the on-going uncertainties in today's commercial real estate markets, financial strength remains a crucial advantage, in both leasing, and in acquisitions. Tenants continue to underwrite landlords for their ability to execute on promises and property maintenance. Sellers continue to prefer buyers who come without financing contingencies, and who can provide surety of execution.

Now, let me give you some details on the four acquisitions we completed in the quarter. In May, we closed on the purchase of 303 Second Street, a 732,000 square foot office project in the South Financial District of San Francisco for approximately $233 million. The property is currently 89.7% occupied, and we recently signed a 37,000 square foot lease that brings the project to 94.7% leased. This puts us ahead of our budget in terms of lease up timing.

As we've mentioned previously, this was a strategic acquisition that allows KRC to diversify its geographic footprint, with a significant foothold in the San Francisco market, an area in which we anticipate future growth.

In June, we purchased a 99,000 square foot office building in the city of Orange for approximately $22 million. The property which is near Children's Hospital of Orange County, came with entitlement rights for additional potential development of office or medical space up to 1 million square feet. It is currently 100% occupied by a single tenant with strong credit quality. The initial cap rate is 7%, but with a contractual rent bump scheduled for next June, the return will jump to 8.6%.

Also this June, we completed the acquisition of a 272,000 square foot office building located in the city of Irvine in Orange County for approximately $103 million. The building, which was completed just three years ago, is a premier address and a best in class property, not only within the John Wayne Airport sub market, where it is located, but across Orange County. It is a LEED certified silver (inaudible) rating in the airport submarket. The building is currently 96% occupied, with two largest leases expiring approximately eight years from now. The in place first year cap rate is 6.7%.

Finally, at the end of June, we completed the assumption of $52 million of CMBS debt that delayed the closing on the remaining three Mission City Corporate Center buildings in San Diego. We closed on the first building in March. We now own 100% of the four-building campus, which is 78% occupied.

Taking all that together, half way through the year, we've made good progress on our most important goals. We've maintained leasing momentum, we've continued to strengthen our balance sheet, we're working to improve our land entitlements, and we've completed four acquisitions that we believe will add significant long-term value to the portfolio.

Now, let's briefly review conditions in our individual markets, beginning in San Diego. Overall, we executed 407,000 square feet of office leases in San Diego year-to-date and have outstanding LOIs of 145,000 square feet.

As I mentioned, San Diego has experienced positive absorption for two quarters in a row, and with the addition of our recent acquisition here, our San Diego properties are now 81.5% occupied and 86.5% leased. Current vacancy and occupancy rates for individual San Diego submarkets in which KRC operates are as follows. In Del Mar, direct vacancy is approximately 15.3% and total vacancy is 19.2%. Our stabilized properties in Del Mar, which total 1.5 million square feet, are 94.5% occupied and 95.2% leased.

South of Del Mar in Sorrento Mesa, KRC competes in the two- and three-story office market. Direct vacancy for this product type is currently 10.7%, and total vacancy is 12.6%, which is little changed from last quarter. We have stabilized properties in the submarket totaling approximately 2 million square feet that are currently 77.9% occupied and 82.1% leased.

Further south in the UTC, Governor Park submarket, we compete in the same two-story product type. Current direct vacancy in the submarket is about 13.3%, and total vacancy about 18.3%. Our properties here total 431,000 square feet and are currently 53.9% occupied, and 86.7% leased.

Along the I-15 corridor east of Del Mar, KRC owns approximately 1.2 million square feet of stabilized office space. The two-story product type here has a current direct vacancy rate of 12% and total vacancy of 12.6%. For class A product, direct vacancy is 29.7% and total vacancy is 30.4%. Our stabilized properties here are 81.5% occupied and 84.6% leased. In the Mission Valley submarket, direct vacancy is about 21.7%, and total vacancy is about 23.4%. As I mentioned, our project here totals 279,000 square feet and is currently 78% occupied and leased.

Moving north to Orange County, the industrial markets have improved slightly, with positive absorption in the second quarter, leading to a slight dip in the total vacancy rate to 6%. We have about 3.5 million square feet of industrial space here, and our properties are 82.4% occupied, and now 90% leased.

With our two recent office acquisitions in Orange County, we now have approximately 647,000 square feet of office space, which is 78.2% occupied and 78.6% leased. For the overall Orange County office market, total vacancy is 18.3%.

Moving north to the Long Beach Airport, our 1 million square foot campus is currently 91.7% occupied and leased. Overall class A direct vacancy here is 17.4%, and total vacancy is 18.3%.

As we've reported, DeVry's 98,000 square foot lease expires at the end of September. Last month, we executed a Letter of Intent with DeVry, for them to remain in about half the space on a long-term basis.

In El Segundo, our stabilized properties total 1.3 million square feet. They were 97.9% occupied and 98% leased at the end of June. Class A direct vacancy in El Segundo is currently 12.3%, and total vacancy is 13.2%. Boeing's 286,000 square foot lease at 2260 East Imperial Highway expired last week and the building was taken out of service from the stabilized portfolio.

Further north in West L.A., our properties total 680,000 square feet. They are 86.9% occupied and 87.2% leased. Overall direct vacancy in West L.A. is currently 14.9%, and total vacancy is 19%.

And along the 101 corridor, which runs through Northern Los Angeles and Southern Ventura counties, direct vacancy in the Class A product is currently 18.1%, and total vacancy is 18.5%. Our properties in the market are 93.6% occupied, and 94.2% leased. Overall, we are now 93.3% occupied, and 93.6% leased in our Los Angeles County portfolio.

Finally, in San Francisco, we are seeing tenant demand driven by media and technology companies, specifically for creative spaces in the South Financial District. Direct vacancy was 10.8%, and total vacancy was 12.2%, at quarter end in this submarket. As I mentioned earlier, our property in this submarket is currently 89.7% occupied, and 94.7% leased.

That is an update on our market conditions and activity. In closing, let me continue to make -- we continue to make significant progress on our leasing and are seeing more tenant demand than we have over the last couple of quarters. This demand has also translated into a handful of discussions related to potential new development or redevelopment, primarily in San Diego.

Finally, while the number of quality assets for sale remains limited, we continue to pursue acquisition opportunities in Southern California. And we believe our strategic acquisition in San Francisco will help us find new opportunities to expand in the Bay area. As always, we remain disciplined in our approach and we will focus on long term value and a strong balance sheet. Now, Tyler will cover our financial results. Tyler?

Thanks, John. FFO was $0.41 per share in the second quarter, and $0.96 for the first half of the year. While our core results were right on target, FFO was lower by $0.11 a share, related to a tender offer for $150 million of our 3.25% exchangeable notes due 2012.

Of the $0.11 a share, $0.09 was due to the GAAP charge for early extinguishment of debt, and $0.02 was due to higher interest expense from the timing difference between the closing of our bond offering and the completion of the tender offer.

In addition, our second-quarter FFO was $0.02 lower than our forecast, due to acquisition timing and costs. Specifically, the closing of 303 Second Street was delayed about a month, due to slow estoppel collection. We also had higher legal costs that were primarily offset by lower bad debt and higher other income.

Occupancy in our stabilized portfolio was 85.1% at the end of the second quarter, up from 82.8% at the end of the first quarter, and just below our 85.5% occupancy a year ago. By product type, office occupancy was 85.7%, and industrial occupancy was 83.3%. Overall, our properties are now 89% leased.

Same-store NOI in the second quarter was down 7.9% on a GAAP basis and 9.6% on cash basis. For the first 6 months of the year, same-store NOI declined 7.1% on a GAAP basis and 7.5% on a cash basis. For leases that commenced during the second quarter, office rents were off 1.4% on a GAAP basis, and 10.4% on a cash basis, while industrial rents decreased 29% on a GAAP basis and 30.3% on a cash basis. For leases that commenced during the first half of the year, office rents declined 5.7% on a GAAP basis and 16.8% on a cash basis, industrial rents were down 21.4% on a GAAP basis and 24.6% on a cash basis.

As John mentioned, we signed new and renewing leases during the second quarter on 332,000 square feet of space. The majority of these transactions were in Los Angeles and Orange County. Office rents on these leases decreased 12.5% on a GAAP basis and 14.4% on a cash basis. Industrial leases decreased 35.8% on a GAAP basis and 39.8% on a cash basis. Further, in July, we signed 143,000 square feet of leases, of which more than half was in San Diego.

Finally, as a potential sign of improving market conditions, for the 616,000 square feet of Letters of Intent, office rents would increase 2.6% on a GAAP basis and decline only 4.1% on a cash basis. Industrial rents will be down 19% on a GAAP basis and 32.9% on a cash basis. We now estimate that rent levels on our overall portfolio are approximately 10% over market.

Now, let me give you some details on our financing activities during the second quarter and our balance sheet position after the completion of our four acquisitions. On May 24, we completed the $250 million unsecured note offering. The notes mature in ten years and pay interest at an annual rate of 6.625%. The proceeds from this debt offering, combined with the approximately $300 million in proceeds we received from our public equity offering completed in April, we used to fund our recent acquisitions and to finance a tender offer for $150 million of our exchangeable notes.

As John noted, the aggregate purchase price of the four acquisitions closed this quarter was approximately $411 million. We paid $359 million of this in cash, and assumed $52 million of debt in the form of a two-year mortgage, secured by three of the Mission Valley properties. After the completion of these transactions, we ended the second quarter with $150 million balance outstanding on our $550 million unsecured credit line, a debt to market capitalization rate of 39.6%, relatively flat from year-end, and an improved debt maturity profile that extends our maturities out to 2020.

As an update on our bank line process, we anticipate closing a new credit line next week. Given our access to the public debt markets, we've chosen to reduce the borrowing capacity on the new line to $500 million. The facility will have a three-year term with a one-year extension option. Pricing will be LIBOR plus 267.5 basis points, with a 57.5 basis point facility fee.

Since the end of the quarter, we've borrowed an additional $55 million on the bank line to repay a $61 million unsecured note due to mature this week. This has brought the bank line balance to approximately $205 million, positioned us so that we have no debt maturities until the end of 2011.

Now, let me finish with updated 2010 earnings guidance. Let me remind everyone that, given today's economy, we remain cautious in our near term outlook and our ability to accurately forecast. Our internal forecasting and guidance reflect information and market intelligence as we know it today. Significant shifts in the economy and our markets going forward could have a meaningful impact on our results, in ways not currently reflected in our analysis. Taking these caveats into consideration, our assumptions are as follows.

Last quarter, we provided 2010 FFO guidance of $2.07 to $2.22 per share. Our projected year-end occupancy for 2010 remains unchanged at 87%. Although further acquisitions this year are a possibility, given the uncertainty of timing amount, for modeling purposes, we are not including any additional acquisitions in our current 2010 forecasting. As we've discussed, we have significantly improved an already strong balance sheet by issuing ten-year notes, repaying short term maturities, and extending our bank line early. These efforts resulted in higher costs, including the 11% impact of the tender offer in the second quarter I mentioned earlier.

In addition, as I previously mentioned, we incurred higher property-related legal costs during the quarter. While the timing is uncertain, we anticipate that we will recoup a portion of these costs over time.

After adjusting our prior guidance for the $0.11 of higher financing costs and the $0.02 of higher acquisition-related costs, the adjusted guidance would be $1.94 to $2.09 a share. From there, we've tightened the reins a bit, and are now providing updated 2010 FFO guidance of $1.97 to $2.07 a share. That's the latest news from KRC. Now we'll be happy to take your questions. Operator?

Thank you.

(Operator Instructions)

The first question comes from the line of Jamie Feldman, of BofA Merrill Lynch. Please proceed.

Thank you. John, when we saw you at NAREIT, you were pretty optimistic about the number of conversations you were having for the vacant space in the portfolio. Can you give us an update on where things stand today, in terms of -- you had good occupancy growth in the quarter and good leasing in the quarter. How much is still in the pipeline and when do you expect much of that to close?

Well, as I made in my formal remarks, we have over 600,000 square feet of signed Letters of Intent outside of leases that we've completed year-to-date. So, I think that's pretty strong, and certainly stronger than we have seen in the last couple of years on a quarter-to-quarter basis.

But beyond that, we literally have, in San Diego, just about every square foot we have with at least one, in some cases two or three tenants deep looking at them. We haven't seen activity like that over the last couple of years. So, I'm thinking that things are looking pretty decent. We still don't have a lot of pricing power, but having said that, in a recent transaction that I don't want to name the tenant, because it is in LOI stage, but we were able to push up the rent and decrease the tenant approval allowance because we found that they didn't really have many other options in the size range they were talking about.

On the development side, as I mentioned at NAREIT, we've got a handful of folks who we're working with. We're trading paper with a couple back and forth. A couple of them, their RFPs are being refined. We haven't received those yet, or they've been adjusting them. Like I've always said, until Letters of Intent are signed, we don't have a deal, until we have a signed lease for a development, we don't have a deal but I'm feeling that this is a much better environment than I've seen over the last couple of years.

And then can you just provide a little bit more color in terms of the types of tenants? Are these tenants that have been on hold for a while and are finally acting, or is this expansion?

It's a combination of both. We're seeing folks in the medical products field which are expanding, and people in the medical services which are expanding. We're seeing people in the financial management which are expanding, as well as wanting to move into a more efficient campus. We're seeing, on the educational side, some expansion. And then with regard to the law firms and the software companies and that sort of thing, it's a combination of expansion, as well as wanting to be in a particular market. In other words, move out of where they're currently in, either because of obsolete facilities or markets they don't wish to be in any longer.

Okay. Thank you.

You're welcome.

Your next question comes from the line of Michael Bilerman, with Citigroup. Please proceed.

Hello, thanks. It's Josh Attie with Michael. A couple of questions on the guidance. On financing, does it include a LIBOR floor on the line of credit, or does it include an unsecured bond offering to eventually pay down the line?

There is no LIBOR floor in the new bank line. And at this point we don't have any modeled financing to take out the line of credit. As I said, we will be at $205 million on the line presently, and we have a $500 million line. So, for the short term, we don't need to do anything to refinance that.

Were there any covenant changes to the new line versus the old line?

Some modest changes, nothing that material. They added a new debt yield covenant, but effectively, it is very similar.

And what was the impact on the occupancy guidance for the year of the acquisitions that you made, because it seems like the year-end occupancy stayed the same at 87%, but the FFO guidance actually increased. Was there an impact on that occupancy from the properties you acquired?

The occupancy impact from the four acquisitions actually was relatively minor on the overall occupancy. I think it is about 50 basis points of higher occupancy due to the acquisitions, so it didn't really impact the numbers yet. And just to comment on your guidance comment, you were saying that guidance was raised. Effectively, when you adjust for the things I talked about, the midpoint of our guidance basically stayed the same. So, I'm not sure we raised our guidance.

Your occupancy target for the end of the year of 87% is inclusive of any acquisitions you make during the year?

It includes the four acquisitions we've made, and we don't have any others modeled.

And those deals all, because they were more highly occupied, have about a 50 basis point impact on portfolio occupancy?

Correct.

You haven't moved up your occupancy target on a same-store basis?

When we gave our 87% occupancy target last quarter, we had already programmed in two of those acquisitions. So, it's just the other two that we hadn't talked about.

And then maybe just sticking with the same theme, the executive compensation bonus program that was set up at the beginning of the year, which is based on EBITDA targets, revenue targets, operating margin targets, and leasing targets, are those reflective of the portfolio as it stood at that point, so it doesn't include any acquisition activity when the board reviews whether the thresholds are met or not?

Well, we have a budget that we show to the board that has different plans for the year, which -- I'm not sure I understand your question.

Based on the fact that you did -- over $400 million of acquisition, that obviously will mean higher EBITDA, higher revenue, potentially higher operating margins. You would be in the threshold performance a lot easier. So, I'm just trying to figure out, how does the program, which is a minimum of $4 million up to $8.25 million, how do the acquisitions play into those targets?

The acquisitions would be additive to that. In other words, the acquisitions would increase EBITDA, which would make the targets easier to achieve.

So, it's not based on the same --

Not on same store calculations, no. (multiple speakers) whatever happens during the year.

But isn't that a little bit counter-intuitive? I mean, just the fact that you buy assets has nothing to do with -- nowhere in the executive compensation program is it based on bottom line financing the transactions with equity or debt. That seems to be paying management for just going out and buying something without performance tied to it.

Is that a comment or a question?

It is a question. I mean how can you set up --

I think we are overwhelming this conference call with this, if I might say that, Josh. I mean we are happy to answer your questions, but I think we've answered it.

John, I'm sorry, it's Michael Bilerman speaking. I actually think it's a serious issue, that management set up a bonus program at the beginning of the year --

It's EBITDA is but one of many other -- the three other components in the program.

60% of the program is EBITDA and revenue driven, which is totally influenced by buying $400 million of assets. I don't see why that is not an issue.

It may be an issue to you, but that is not our motivation to buy assets.

I understand that, but I would think a bonus program should be bottom-line focused on a same-store basis, not based on deal activity.

Okay.

Well, thank you for clarifying.

Your next question comes from the line of Sri Nagarajan with FBR Capital Markets. Please proceed.

Maybe you can talk about the motivation to acquire assets, particularly in the Mission Valley submarkets where you declare that it is 21% to 22% vacant. What do you see on the ground, that increases acquisition and what is underwriting, in terms of leasing up the Mission Valley conference center?

Well, the buildings were basically stagnant over the last couple of years. The former owner was capital constraint, didn't have the wherewithal to do leasing, had no motivation. Had some guarantees that were involved in the construction of the final building that they wanted to be relieved of related, as they told us, to a much bigger issue elsewhere, and their relationship with the particular banker.

What we looked at, is on a price-per-pound basis it was roughly $250 a foot, Jeff?

Yes, $252.

$252 a foot, that it was well below replacement costs. Right next door is a 500,000 square foot shopping center, so great amenities. And we had talked with the brokers, the various people who represent tenants in that market, what their view was of the asset. And they thought the asset was a terrific asset, one of the top two assets in that marketplace, but had poor sponsorship.

So we took a look at it, and said with its transportation amenities, as well as the retail amenities, and with new sponsorship we could move the leasing up substantially. And right now we have a handful of tenants with proposals going back and forth, from a broad diversity of tenants, where we think we will move that, that square footage leased, up substantially over the course of the next couple of quarters.

So, you are assuming a potential leasing in the next couple of quarters. And, in terms of the 27% of your Los Angeles office rent is expiring. I know you talked about DeVry signing up for about half the space, and obviously Boeing vacating, or are you taking the property out of service. Give us a sense of how the rentals are going for the Los Angeles office. And I am assuming that since the rents are lower, it is most likely Long Beach or El Segundo. So the 16,000 square feet of LOI, what is that to (inaudible) office here?

Jeff, do you want to cover that?

Of the 616,000 square feet of LOI, about 157,000 of that is in L.A. So I think we are seeing reasonable, good activity. Long Beach has been pretty steady. We are continuing to seeing decent demand, although there certainly still is pressure on pricing. In West L.A., the markets continue, I think, to do well, although there still continue to be a lot of competition. So I think [net, net] we are feeling good, but there are some in's and out's of the various submarkets.

Okay. One last question. You have large holes to fill in at say, Governor Park, I-15, Sorrento Mesa. Again, where does your leasing activity look in those particular submarkets, and how does the acquisition overall fit in?

Well, in the UTC Governor Park submarket, we have one vacancy, don't we, Jeff, which is roughly 75,000 square feet. We just have a low base there, we're dealing with two different tenants for that particular building. So we're hopeful we going to move our leasing up in that category as well over the next couple of quarters.

Okay. Thanks.

You're welcome.

Our next question comes from the line of Chris Caton with Morgan Stanley. Please proceed.

Good morning.

Morning.

One question is on occupancy ramp. If you are 85% occupied, 89% leased, and targeting 87 at the end of the year, what do you think that looks like through the end of the year, in terms of third quarter or fourth quarter?

It is pretty straight line. I don't have the number exactly in front of me but we have about 435,000 square feet of expirations remaining, including DeVry and Boeing.

And we think we will do about a third of that, and the remainder will come out there. So there will be in's and out's as John said, but it is pretty straight line over the remainder of the year.

Then with regard to the line, and kind of letting $205 million float, is that what is in the guidance? And then would you contemplate revisiting the unsecured markets now, or is it something you kind of want to let float for a period of time?

We don't have any floating rate debt, so I think 80% of our debt is fixed rate, or more than 80% is fixed rate. So we don't mind having a little bit float. But we are certainly going to watch the markets, and see what may change.

There is also -- even though we raised unsecured debt, the secured market is clearly very strong right now. And even though our strategy over the long run is to do a lot more secured debt, we may tap it here and there, just to take advantage of good pricing. But, I guess the bottom line is, we don't mind watching -- or having a little bit of floating rate debt.

Great. Then the last one is with regard to dividend coverage. I think in the back of this sub, you have FAD at $10.7 million. What -- when you look at the free rent you are giving, in terms of new deals, as well as CapEx, when do you think you get back to a positive dividend coverage?

I mean it depends on our leasing, obviously. We have all these LOIs in place, which is the good news. But obviously, there will be TIs and leasing commissions associated with that. So it is certainly not until next year. But I can't give you a specific quarter on that.

And you are comfortable kind of over paying the dividend as you put capital into the space?

Yes.

Thank you.

Our next question comes from the line of John Guinee with Stifel Nicolaus. Please proceed.

John Guinee here, thank you. A couple of sort of administrative questions. Tyler, I am looking back over your future development pipeline, your land. It looks like the total cost is going up about $3 million a quarter. How much of this 116 acres are you capitalizing the interest and other costs, and how much are you expensing?

We are capitalizing on the San Diego Corporate Center project in San Diego, that Del Mar project. And we have been capitalizing on Santa Fe Summit, as well, but that will end this quarter, I think this month, actually. Those are the two projects we have been capitalizing the interest on.

Okay, alright, next question. You guys, John, have kind of an interesting portfolio, 140 buildings, 13.7 million square feet , so roughly 100,000 square feet per building. As of last quarter, you had 15 full buildings vacant. Can you kind of walk through the pluses and minuses of trying to lease full buildings versus just a single floor in these various

Well, it is going to be building by building specific. But we have industrial and we have office, Jeff. How many of the --- what did you say, 15 buildings were vacant? How many of them are vacant now? I have never been asked that question, so I don't have that number on the top of my head.

But in terms of different markets, of course, San Diego, Sorrento Mesa and UTC, where we have the two-story product type, and the two-story product-type out on the I-15 tend to be more headquarters and/or large user markets. So multi-tenant buildings typically there are not something we want to be in, unless it is -- sub cases will be 6 story buildings, so you would be multi-tenant. But I am not quite sure what your question is -- I lost your question.

I guess the question, do these markets tend to evolve from large user markets to small user markets? And, really, I am trying to get a sense for are these buildings, in fact, subdividable, or are you really (multiple speakers)?

Oh, yes. They are subdividable. In fact, the buildings out on I-15 that we got back from [a credit] home lenders that went bankrupt, there are three buildings total. Jeff, 178,000 square feet. And how many tenants do we have in there now? We leased two of the buildings. We have a Letter of Intent on another. And we have got a couple of residual pieces of space, because we designed them so we could break them apart, and we are leasing -- we have strong interest from others on those. So all the buildings we designed, we designed to be multi-tenant, whether it's per floor, or whether it is breaking up a floor, it just depends on where the demand is at any particular time.

You look at Building Lot 3, Sorrento Gateway, a 2-story building. We made a deal for a floor with Samsung. Then they came along, and they took three-quarters of the balance of the second floor. And now I believe they are going to in all likelihood, take the entirety of that remaining space. So they would be one tenant for both floors, but they started out incrementally.

And then the last question, I guess, Jeff, it might be a good, quick study. When you take 2260 Imperial highway, the Boeing building out of the service, what net rent do you have in it, while Boeing is there last year? How much are you going to put in the building in terms of base building, TI's, leasing commissions? And then what would you expect the net rent to be, once you are able to release it?

I will start with the redevelopment costs. We are looking to put about $20 million in, in terms of upgrades, the lobby, rest remodels, hardscape, softscape, landscape, all the redevelopment pieces of that. Then on the tenant improvement side, with tenant improvements and lease commissions, probably about another $65 a foot. We feel very confident in where the building is and position in the marketplace, in terms of where the old rent was expiring with Boeing, and the rent we will be able to achieve going forward will be actually a nice increase. It obviously depends on the exact timing, but we are very confident the rents are going to be up pretty significantly.

What is Boeing paying now?

They are paying basically, $1.20 triple net.

They are only paying $15?

Remember, what we did? Remember, we always said, we want to get Boeing out. We did a short term renewal as-is? That is why we did such a low rate deal with them.

Got you. Okay, great. Thank you very much.

You're welcome.

Your next question comes from the line of George Auerbach with ISI Group.

Great, thanks. Tyler, how should we think about G&A expense for the full-year? You have been running in the low $7 million range over the last several quarters. But give the comp plan impact, and also the potential to maybe add head count on the expanded portfolio, I guess what does your guidance assume for the back half of the year?

We have included the full value of the comp plan in the numbers, which I think we said before. The G&A run rate is around $7 million a quarter, and we anticipate it will stay that way, $7 million to $7.1 million a quarter.

And just to make a point on the comp plan in general. I think back to Michael Bilerman's point, if we excluded the acquisitions, at least our targets at the moment given that we improved our occupancy on a same-store basis, we would still achieve 100% target. So the acquisitions are not impacting the results of the comp plan.

All right. Thank you.

And your next question comes from the line of Suzanne Kim with Credit Suisse.

I am just trying to get more color on the 616,000 square feet of LOIs that you have done. Is there a geographic sort of theme there? Is there a product theme? And do you have a timeline on when these potentially could kick in? And the last point is, how much of this is actually a preleasing of expiries that are a couple years out?

Jeff, do you want to handle that?

Yes, let me see if I can take a cut at it. The 616,000 square feet of LOIs, about 53% of them are new, for new space that versus renewal, and about 52% of that 616,000 square feet is office versus industrial.

And when do you expect these to kick in? I mean, would this be something we would sort of see in the first half, second half?

Obviously we haven't signed the leases yet, so it is hard to project them specifically, but it is certainly probably mostly a 2011 throughout the year next year.

Throughout the year of 2011?

Yes. It just depends on how long it takes us to execute the leases.

Sure. And how much of it was -- in terms of the remaining, I guess 53% was new space -- how much of the renewals were as a result of expiries that were a couple years out?

In terms of the renewal, how far are those 2010 versus 2011?

Are those 2013s that they preleasing at this point? They decided they will go in now, because they can get a better rate?

They are just mostly 2010 and 2011..

Great. Thank you so much.

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

Hi, guys, a question on just the re-leasing costs. It looked like you had some longer term deals this quarter than you have had before, and so the CapEx was a little higher. It looks like about $5.25 per foot per year on the TI's and leasing? I was just wondering if you can maybe give us gross or net rent that would roughly correspond to that, so we can get a little better look at the net effect on these deals?

The rents were all -- given some of it is industrial and some of it's office, it is hard to give you one number for that.

I think my number was just office only. Sorry. I didn't clarify that.

Right. But even within the office portfolio, you have got full service gross, and have triple net deals in L.A. versus San Diego. And the rents are just different there, so even if we gave you a number, I am not sure it would be helpful.

Yes, it just makes it hard to evaluate what the net effect is. Okay. And then, can I ask, also, it looked like the same-store property operating expenses were up a fair bit in the second quarter year-over-year. I just was wondering if you could give some color on why that was?

As I mentioned, we had higher legal costs this quarter, related to four separate issues we are dealing with. And that was the bulk of it. It was over $1 million related to that. As I said, we hope to recoup some of that down the road. But it was primarily a reflection of legal costs.

And that flows through property operating?

Yes, they are property-related issues.

Okay. And then, on the leases that you are doing that seem a little bit longer on the whole, can you just comment on what kind of rent bumps you are getting on these deals now? And maybe also on sort of your recently signed deals, and then, just remind us of what it was maybe at the peak? Have the terms of rent bumps changed in your markets much over the past couple of years?

Well, the peak would have been -- we generally have been anywhere from 2.5% to 4%. And that is -- what we are getting right now is in the 3% to 4% category. So I don't think it has moved off the peak, Michael. In some cases, it is not annual, it's every two years, but it's the equivalent of that math.

Right, okay. That is helpful. And then, John, while I have got you, can you just give me a little color behind the strategy on Orange? I totally get the Michelson deal, and the appeal of that particular submarket here within Orange County, but I am still a little curious on your thought process on Orange. Is it kind of a development play? Is that why you were attracted to that? Can you give us some color there?

Well, the lease goes out, Jeff, to 2018. It is a credit tenant. It's going to be -- it's a decent yield, it goes 8.5 next year. It's got bumps thereafter. They just spent millions of dollars in the building. They have been there some period of time. It is zoned to a 3 FAR, and it's developed to a 0.3 FAR. So in round numbers you can take the 99,000 square feet up to 1 million. I don't think that is where we could go, unless somebody came along. But what is happening out there at Chalk, which is right across the freeway is that Chalk as been buying up the neighboring buildings And it has displaced a lot of the doctors. So as they have grown, more doctors want to be there. Also, as they grown, they've displaced places where doctor's offices. And we can build on the site somewhere in the neighborhood of 75,000 to 100,000 square feet with existing parking and so forth, and essentially, free land. We would only do that if it was preleased.

So we looked at this and said to ourselves, there is great opportunity here to reap more value. Whether that happens now, or whether it happens three or four years down the road, in the meantime, we have got an asset that is well located, very well leased, good yield, and it was $23 million. So, it was a pretty easy decision.

Thanks for that. I appreciate it.

You won't see us buying $23 million buildings, unless there is -- it is relatively close to an existing market, where there is some kind of big value added play. But, our focus is on buying something that is larger.

Right. Thank you.

You're welcome.

Your next question comes from the line of Vincent Chow with Deutsche Bank. Please proceed.

Hi, everyone, just a question -- I am looking for some color around the cash [lease spread] line numbers, which have been bouncing around a fair amount over the last couple of quarters. I was just wondering if you can give us color on when that might stabilize, in light of the fact that cash lease spreads seem like they are moving in the right direction, and occupancy is picking up here?

We do expect by the fourth quarter if our numbers hold then we will have positive same-store growth in the fourth quarter. It will get better in the third, and should turn positive in the fourth, very slightly, but it is heading in the right direction.

Okay. And by that, is that suggesting TI's and concession packages, the pressure on those are diminishing or you expect them to diminish?

Well, you are talking about the same store NOI?

Just cash same-store NOI?

That wouldn't be impacted by TI. But basically with occupancy moving up, and that will help our numbers, as well as we don't think we will have the higher expenses we had in the second quarter.

Okay. Thanks.

Your next question comes from the line of William Chiew with Cowen and Company. Please proceed.

This is actually Jim Sullivan at Cowen. Just on that last point, Tyler, to follow-up, you said you wouldn't expect the operating expense to be so high. So, they will be coming down. You also in your comments about the legal cost that tended to inflate that OpEx number in this quarter you talked about, you hoped to recover or recoup some of those. Could you go into that in a little more detail?

Not only as I understand it, not only will the OpEx line should come down to a trend line level to where it has been over the last couple of years, but there is actually a number in here you might actually recover. Is that right? Did I understand that right?

It is possible. Yes, we were hoping --- I mean, obviously it is litigation so we can't go into the details, but we're hoping that we can recover some of our legal costs we have incurred. Just to be clear on property expenses, we have higher property expenses in the second quarter. They should moderate somewhat in the third and fourth quarter, but I wouldn't say completely. But to answer your question, we do hope to get some of those legal cost back.

On the OpEx line then, just to make sure we understand the degree of moderation, historically you tended to do about 17.5% of the top line, in the OpEx line. And the prior peak that we have seen was about 18.5%, whereas this quarter it was over 20%. So are we looking at anumber what that is going to be settling back at an 18%, or back to a 17.5%? Can you give us any more --?

If you took out the legal costs from last quarter, I think you get to 18.5%. And obviously the third quarter is a little different because you have the impact of higher utilities from the summer, and you have got -- real estate taxes take their 2% increase in the 3rd quarter, as well. It is a little bit seasonal, but I think assuming we don't have the same level of legal costs, we will be back in that 18%-ish range.

Very good. Thanks.

Your next question comes from the line of Mitchell Germain, with [Kilgore Realty]. Please proceed.

Hi. It is Mitch with JMP. Tyler, can you provide the different targets of the four components of the comp plan, please?

The metrics, we haven't disclosed the targets on the 2010 metrics. The metrics are EBITDA revenues, leasing and margins.

Will you be providing those different metrics?

I believe we will be disclosing those at the time the program is finalized at the end of the year.

Just to confirm, I think it was asked earlier, and I apologize, if the maximum threshold is achieved, is that currently being contemplated in the guidance that you provided?

Yes.

Thanks.

Your next question comes from the line of David Rodgers, of RBC Capital Markets. Please proceed.

Thank you. John, you mentioned at NAREIT, and I think you mentioned again today, the opportunity for maybe some developments in San Diego in particular. How do you think about where you should be doing some build-to-suits today? What types of yields you would expect to get, versus not only your cost of capital, but where you are looking to deploy capital on an acquisition basis? Thank you.

Well, on the first part, on the development side, we have historical been in a bandwidth of about 8% to 10% going in yields, with sometimes better, that's unleveraged, of course. And that tends to be, again, the bandwidth, and the upgrade into that seems to be in a more robust period, when there is quite a bit more demand. So, I think we would still be in that range, but probably at the lower end today. If some of the redevelopment stuff we're looking at, that might be a little better. Was your second part of the question with regard to acquisitions where we ought to be?

Or just the spread, between putting money to build-to-suit, if you are buying in the mid-7's, is developing at an 8 and up, etc.

Well, let me differentiate here, too. If we are going to go out and buy a piece of property for a development, we are going to look at it a little differently, than if we are going to consume an existing piece of land that we already own. So, there is going to be some differential pricing there on a development activity between those two scenarios.

Then looking at your other question in terms of acquisitions, you have seen a bandwidth of sort of 6, 7, to 8-plus on our acquisitions, with the average being in the high 6's, I guess, Tyler, in terms of going in.

And our underwriting is based upon what we think we're going to do over some period of time, not just at one point in time. As you have seen, what we bought, with the exception of San Diego, the Mission City stuff, which was 78%, the other buildings were in the high 80's, early 90's, or in the case of that little building in Orange County, 100%. What we liked about all of those, there was we thought an opportunity to substantially increase the value of those over the next five years or so. We liked the fact that there were decent going in yields. I wouldn't call them extraordinary, but where we can move both a price per pound basis, as well as yields over time up substantially. So, does that do it for you?

That helps. Thank you.

Okay.

Your next question comes from the line of is a follow-up from the line of Suzanne Kim with Credit Suisse. Please proceed.

I am not sure if you discussed this already. But the Orange site, I am just wondering if there is a development opportunity there presently, or if it is something you are talking about you will have to do a complete demolition in order to maximize on the FAR that the land permits right now.

Let me tell you again where we are on that. The property is currently developed to 0.3 FAR, and it is roughly 100,000 feet. It is zoned for 3.0 FAR, which would permit roughly 1 million square feet. If we built more than about 100,000 square feet -- 75,000 to 100,000 square feet on site, we would either have to go with a very tall building, which we don't intend to do, or we would have to tear down the existing building, which we can't do, until the tenant moves out.

Our thinking, is the more likely scenario is that we would end up building 75,000 to 100,000 square feet with substantial preleasing, But over time, if we haven't done that, and the lease runs, and we still own the asset, then we could do something that's bigger.

So there is land available adjacent to the property (multiple speakers) right now?

Yes.

Great. Thank you.

Your next question comes from the line of Michael Knott, of Green Street Advisors. Please proceed.

John or Jeff, I just wanted today ask if you heard anything in your markets about tenants' behavior or decisions potentially being influenced by the pending changes in lease accounting, from a tenant standpoint, and whether that makes any tenants more likely to want to own their own space as opposed to leasing?

Michael, this is Jeff. I haven't at this point heard or seen anything regarding lease accounting that would suggest that that is under way or under foot at this point.

Thank you.

At this time there are no further questions. I would now like to now turn the call back over to Mr. Tyler Rose for closing remarks.

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

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