Kilroy Realty Corp (KRC) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2010 Kilroy Realty Corp. earnings conference call. My name is Tony and I'll be your coordinator for today.

At this time, all participants are in listen only mode. We will conduct a question and answer session towards the end of the conference. (Operator Instructions) As a reminder this call is being recorded for replay purposes.

I would now like to hand the call over to your host for today, Mr. Tyler Rose, CFO. Please proceed, sir.

Good morning, everyone. Thank you for joining us. With me today are John Kilroy, our CEO, Jeff Hawken, our COO, Chris Corpuz, our Head of Acquisitions, Heidi Roth, our Controller, and Michelle Ngo, our Treasurer.

At the outset, I need to say 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 10 days both by phone and 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 in a bit of a change from prior quarters, we'll provide general commentary on our various markets rather than specific market statistics. We have added a page to our supplemental that includes the detailed market data.

I will follow John with financial highlight the and updated earnings guidance for 2010 and then we'll be happy to take your questions.

John?

Thanks, Tyler. Hello, everyone and thank you for joining us today. We had another fast paced and successful quarter at KRC. We're excited to report continued leasing success as well as announce that we are under contract on two new acquisitions.

Let me start with a brief review of our market conditions. Overall, we believe we have seen the bottom in most of our markets, although the recovery is relatively muted by historical standards.

Having said that, San Diego has now experienced positive absorption for three quarters in a row and we are now 82% occupied and 87% leased there.

The Orange County industrial market had slightly negative absorption in the third quarter but we have moved our occupancy to 90% and are over 94% leased in that market. And the Orange County office market had positive absorption for the first time since 2007.

In Los Angeles and Ventura Counties we're seeing modest activity. Absorption was slightly negative in the third quarter but our occupancy is holding at 90%. That's down from 93% at the end of the second quarter driven partially by taking our 300,000 square foot 2260 building, previously occupied by Boeing and El Segundo, out of service for a planned redevelopment that commenced in August.

And finally in the South Financial District of San Francisco, where our 303 Second Street building is located and where one of our just announced acquisitions is also located, demand is growing with total vacancy rate of 12.6%, a full five points below that of the overall market.

Jones Lang LaSalle has reported quarter-over-quarter rent increases of 7% in this submarket driven by significant demand from the tech sector. In addition, one of San Francisco's preeminent real estate brokerage firms, CAC, is reporting that 2010 will be the biggest year yet in terms of leasing with tech related companies.

At KRC, we are benefiting from these modest improvements in market conditions as well as a tenant flight to quality and an increased preference by tenants to do business with well capitalized landlords.

We maintained strong leasing traction during the quarter and signed almost 462,000 square feet of leases. Year-to-date we've now signed leases on more than 1.3 million square feet, about 80% of our lease transactions in the third quarter were for office space, over 50% were in the San Diego submarkets and about two-thirds of the transactions were on vacant space.

Strong leasing continues to boost our occupancy levels. At the end of the third quarter, occupancy in our stabilized portfolio was 86.4% up from 85.1% at the end of the second quarter and up 360 bips from 82.8% at year-end 2009. Our stabilized portfolio was 89% leased at the end of the quarter.

Since the end of the third quarter, we've signed additional leases totaling 227,000 square feet including a large industrial lease in our Orange County industrial portfolio.

In addition, we now have approximately 550,000 square feet of in place letters of intent of which about half are for new leases and half are for office space in San Diego.

Based upon the level of interest that we are seeing today throughout most of our portfolio, particularly in San Diego and Orange County, we anticipate that we will continue to make occupancy gains.

Turning to our growth initiatives, our investment strategy is simple and straightforward. We aim to take advantage of certain inflection points as the real estate cycle progresses.

In the early stages, where we are right now, our strategy is to buy high quality, irreplaceable core assets in top tier markets at discounts to replacement cost.

We seek well-leased properties with sufficient term to get us to a better point in the cycle. This should generate good stabilized yields with the ability to grow them over time.

As the recovery begins to gain steam and job growth occurs, we will move further out on the risk curve to purchase more value-added acquisitions with more lease up opportunity.

Finally, when we reach a strong recovery that includes significant tenant demand, lower vacancies and higher rent growth, we anticipate that we will once again focus more of our investment attention on development where historically at that point in the cycle, we have achieved superior risk adjusted returns.

Over the last 13 years, we have invested roughly equal amounts of capital in development and acquisitions. In the real estate bubble markets of 2005 through 2007, we invested nearly $450 million in development starts at yields 300 to 500 basis points higher than the acquisition cap rates at the same time.

This year given where we are in the cycle, we are focusing more on acquisitions year-to-date and assuming we close on our two pending transactions, we will have invested the nearly $667 million in acquisitions purchasing high quality assets in terrific locations at meaningful discounts to replacement costs.

Our buying criteria's disciplined and clear cut. We stick to what we know. We're pursuing opportunities in key West Coast locations where we have deep market knowledge and experience.

We buy properties at prices below replacement costs that include significant amenities and great access to transportation and infrastructure.

We look for properties where we can increase rents as well as those that are well leased and provide current cash flow.

Finally, in all of our acquisition efforts, our primary objective is to purchase properties that will appreciate over time, to build significant shareholder value.

Our two pending acquisitions reflect these priorities. We are currently in escrow to purchase 100 First Plaza, a 466,000 square foot 27 story office property located at the corner at First and Mission Streets in the South Financial District of San Francisco. The purchase price is approximately $191 million or $410 per square foot.

This is a strategic opportunity to buy a property that will be a direct beneficiary of San Francisco's $1.7 billion Transbay Terminal project where work has already begun. This publicly funded multi-modal infrastructure project will include new terminals to accommodate multiple types of transportation, a 5.4-acre park and new housing, retail and commercial properties.

100 First Plaza is directly adjacent to these improvements. The new terminal has been dubbed the Grand Central Station of the West. These transformational improvements will further enhance the areas attractiveness and the value of our projects at 303 Second Street and 100 First Plaza.

As many of you know the area south of Market which includes the South Financial District has experienced a major revitalization over the last several years and now with the addition of the Transbay Terminal has only improved its position as a preferred location for media and tech tenants including those in the search, social and mobile media, cloud computing, and similar industries.

As I mentioned earlier, this market is outperforming San Francisco's traditional CBD and has captured the bulk of recent leasing in the overall market.

For example, we have moved our lease percentage at 303 Second Street from 89% to 96% since we acquired the project just five years ago.

100 First Plaza is a LEED Gold certified building and is currently 76% occupied and 94% leased to top credit tenants. The average lease term extends for another six years so the building represents both strong current cash flow and excellent appreciation potential.

The initial return at 76% occupancy is approximately 5% upon stabilization of current leasing, at 94% occupancy the yield will be approximately 7%.

This acquisition is a perfect example of an opportunity that was not formally marketed but one that we pursued given our view that the asset will be substantially enhanced in value by the Transbay Terminal improvements.

Upon completing our acquisition of 100 First Plaza we will have roughly 1.2 million square feet in the South Financial District with 95% of the total space leased.

In a separate transaction, we are also in escrow to purchase Overlake Office Center, a 122,000 square foot three story office property located in Bellevue area of Greater Seattle for approximately $46 million or $377 per foot.

The building is directly across the street from Microsoft's main corporate campus and is 100% leased to Microsoft through December 2014. This is an opportunistic buy in an off market transaction of a terrific asset. The price is below replacement cost and well below recent sales in the area.

Building rents are below market and a $30 million overpass that connects the property to Microsoft's campus is expected to open by year-end. The initial yield is projected to be approximately 6.4%.

Just as we had the previous track record in the Bay Area, KRC has had a 30 year plus track record in the Greater Seattle area. We sold our last asset there in 2007 at a cyclical peak in real estate values.

We have a strong understanding of the dynamics of this market and we believe in its continued growth especially in the affluent and tech heavy locations like Bellevue Redmond corridor.

In summary, we continue to make significant leasing progress and expect to make further occupancy gains, given the demand we are seeing in most of our markets.

In San Diego we believe we have turned the corner from a growth perspective, we believe we are in the initial stages of recovery, when acquiring quality, well leased properties that have strong value drivers makes sense.

Our pending acquisitions are well leased with strong cash flow and provide the opportunity to significantly increase value over the long term.

100 First Plaza further solidifies our San Francisco presence and expands KRC's platform in what has become San Francisco's strongest submarket.

That's an update on the quarter, now Tyler will cover our financial results.

Thanks, John. FFO was $0.54 per share in the third quarter and $1.51 for the first nine months of the year. We ended the third quarter with occupancy in our statewide portfolio at 86.4% up from 85.1% at the end of the second quarter.

By product type, office occupancy was 84.8% and industrial occupancy was 90.6%. Overall our properties are now 90% leased.

Our third quarter same-store NOI increased 2.9% on a GAAP basis, just under 1% on a cash basis. For the first nine months of the year, same-store NOI declined 3.1% on a GAAP basis and 4.8% on a cash basis.

For leases that commenced in the third quarter, office rents were off 19.5% on a GAAP basis and 5.2% on a cash basis, industrial rents decreased 22.3% on a GAAP basis and 30.9% on a cash basis.

For leases that commenced in the first nine months of the year, office rents declined 14.1% on a GAAP basis and 11.3% on a cash basis, industrial rents were down 22% on a GAAP basis and 28.3% on a cash basis.

As John mentioned, we signed new and renewing leases during the second quarter on 462,000 square feet of space. Office rents on these leases decreased 6.4% on a GAAP basis and 8.7% on a cash basis.

Industrial leases decreased 2.9% on a GAAP basis and 15.3% on a cash basis.

Further in October, we have signed 227,000 square feet of leases most of which are in Orange County.

Finally for the 450,000 square feet of letters of intent, office rents would increase 1.7% on a GAAP basis and be down 5.6% on a cash basis.

Industrial rents would decrease 20.6% on a GAAP basis and 27.4% on a cash basis.

Rent levels remain relatively flat and we continue to estimate that rents in our overall portfolio of approximately 10% over market. We have manageable lease expirations in 2011 as approximately 8% of our portfolio rolls over next year. That compares to about 16% this year.

In terms of funding the acquisitions, we currently have approximately $275 million of capacity in our bank line and we can expand it another $200 million through an accordion feature.

Given our low leverage, we plan to take advantage of the low interest rate environment and currently evaluating the issuance of both unsecured and secured debt.

The Seattle acquisition is expected to close later this week and the San Francisco acquisition is expected to close in early November depending on due diligence items.

In addition, we do anticipate increasing our disposition program in order to fund our growth initiatives. As you know, we've utilized this capital recycling strategy since our IPO.

As in the past, we'll provide 2011 guidance including projected dispositions on our fourth quarter call.

Finally, we will post on our website more property specific information on the acquisition subsequent to closing and we're also working on setting up an Investor Day in San Francisco. More to come on that.

Now let me finish with updated 2010 earnings guidance. 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 market going forward could have a meaningful impact on results in ways not currently reflected in our analysis.

Taking these caveats into consideration, our assumptions are as follows, last quarter we provided guidance of $1.97 to $2.07 a share and year-end occupancy guidance of 87%.

Given our stronger than forecasted leasing performance, we've now increased our projected year-end 2010 occupancy guidance to 88%. We also expect about a penny of higher acquisition related expenses with accretion from the pending acquisitions offsetting most of these costs.

After adjusting our prior guidance for these factors and further tightening the range a bit, we're now providing updated 2010 FFO guidance of $2.01 to $2.06 a share.

That's the latest news there KRC. Now we'll be happy to take your questions. Operator?

(Operator Instructions) Your first question comes from the line of John Guinee of Stifel. Please proceed.

Very nice job, guys. John, you talked a lot about replacement costs in the markets. Can you talk about what you think it costs to replace the building you just bought at First and Mission versus what you bought at Second and Howard? And then also the low rise building you bought in Seattle -- or in Bellevue?

Well I think it's San Francisco, rather, John if you're talking a Class A building, you're going to be well north of $600 a square foot, depending upon the height and so forth and what your land cost is.

Anymore color (inaudible) --?

Seattle was that the other question?

-- building versus land versus [TIs] on that sort of product?

Pardon me?

Anymore color in terms of base building costs versus TIs versus land on that sort of product?

Well, I really haven't gone through the details on either of the two San Francisco replacement costs just because what we bought them at is such --- bought then for is such a discount to replacement cost. I mean, I could go through and figure out all of the shell and the rest.

I know the current projections on cost in a high rise that was recently priced in the Transbay Area, which is a taller building, is reportedly to be well north of $800 a square feet.

Okay, how about the Bellevue market?

The Bellevue market, that particular building is we think is going to be well north of $450 a foot. One of the things that was appealing in that building beyond the position that it commands with Microsoft, it's the only building they don't own in the entire area that Microsoft put in just under $100 a square foot of tenant improvements above what the base building provided.

Great. Thank you very much.

You're welcome.

And your next question comes from the line of Dave Rodgers of RBC Capital Markets. Please proceed.

Yes, thank you. John, in the second quarter we saw that TIs were higher. Can you give us some color on the recent lease signings in terms of where your office TIs and concessions would be overall and what we should expect to see in terms of commencement with regard to the leasing that you've done in the next couple of quarters?

Well, let's break that down if I may, Dave, into two questions. The first is TI. The second is going to be starts. I'll let Tyler or Jeff deal with the latter.

In terms of TIs, it's all over the lot. We're just doing a deal -- we just signed a Letter of Intent with some folks where it's a major renovation of a project. It's north of 100,000 square feet. We're putting up $10 a square foot. They are putting in many many multiples of that and we got a great rate.

In some cases, if it's a 10-plus year lease and it's a corporate headquarters, it might be as much as $60 a square foot, plus or minus.

Jeff do you want to add any color or Tyler to that?

Well I think two points on the TIs and leasing Commission you probably saw that our numbers were significantly lower in the third quarter versus the second quarter on overall renewals and new leases.

We do expect that to come back up in the fourth quarter, but not as high as it was in the second quarter but I don't think we're going to maintain the $16 a square foot or so that we had in the second quarter.

In terms of when the leases start, most of it starts next year, there's a few smaller leases that start this year. There's one big industrial lease that does start in November of this year that will move in on November 1, but most of the remainder of the leasing is scattered throughout the first half of next year.

And then with I guess other concessions, I mean are concessions still prevalent in the market? Can you give us some sense of market level conditions with regard to those?

This is Jeff. Yes, it really depends market to market but there's still a fair amount of concessions in terms of free rent, a month, a year in term tenants are looking for TIs on a turnkey basis to the extent they can get that.

In some cases there's just kind of (inaudible), depends on what the market is. So it's really no change over the last quarter or two.

No change, okay. Thanks for the color there. Last question for Tyler. You didn't mention equity as a possible source [for] proceeds for the recently announced acquisition.

Is that on the table as well or do you feel that you're well capitalized enough to continue to pursue your opportunities in the near term?

We think we're well capitalized enough. We raised more equity than we needed back in May and our leverage is sort of in the mid 30s right now so we have some room to run on debt and as I mentioned we're looking at some debt opportunities right now.

Great, thanks.

Your next question comes from the line of Jim Sullivan of Cowen & Co. Please proceed.

Thank you. A question on the two acquisitions. John, you talked about the discount to replacement cost and you already addressed that and I'm curious, there was -- in the prepared comments there was I think Tyler might have talked about the current rent roll having a negative mark-to-market of 10%.

I wonder if you could offer an opinion on the mark-to-market of the leases in place on the two acquired assets?

One of the things we really like about these two assets that in both cases they -- while there can be the occasion where you have a lease that is slightly above market when you look at the average, it's well below current market so we feel we have very little roll down exposure based upon where current rents are today in the buildings versus where current market is.

Now obviously if current market were to deteriorate further, that could create some problems. But it's -- some of the things that we really liked about these buildings and just as we liked about 303 Market. You'll recall in that building, five-sevenths of the building had been leased in the two years prior to the time that we bought it so it had been leased right at the downturn, so we think there's very little roll down at this point in those assets.

Also, you commented on the -- I guess the third consecutive quarter of positive absorption in the San Diego office market. And I'm curious if you can talk a little bit about where the demand is coming from within different industry groups?

I know you've got a good diversification among your tenant base, but by industry groups, but is it -- is healthcare the primary driver?

No, but it's certainly one. And healthcare, there's medical products, there's healthcare providers, there's the MOB side of life which is Medical Office Building, and then there is software, there's financial, wealth management groups.

There is also in the greater heading of healthcare the pharma and life science crowd that are requiring some more space. There is, as I mentioned software, there's financial processing and there's construction, oddly enough we've done a deal with a construction company. I think we're doing a deal with another construction company, in both case they are either headquarters or western US headquarters, well capitalized companies doing massive amounts of projects not in the private sector but in the public sector with a huge book of business.

What have I missed there, Jeff? It's been --- it's been very diversified of course as we move further up, out of San Diego into LA and then of course up to San Francisco, we start to introduce the entertainment crowds and a greater degree of tech companies and the gaming industry and so forth.

Okay, and then final a question for me, on the bad debt provision line that was a positive number this quarter. I'm assuming that was a one off transaction unlikely to be repeated next quarter?

That's right, that's right.

Okay, thank you.

You're welcome.

And your next question comes from the line of Steve Sakwa.

Good afternoon. I just wanted to clarify. John, I thought you had said that you had 550,000 feet of Letters of Intent and then I thought I heard Tyler say 450 so I just wanted to clarify which one?

It's 550,000, that was my mistake.

That's okay. And I think again to clarify you said half of that was in San Diego, John?

That's right. About half is San Diego and that's all office and half was for new leases and half was for renewal leases.

And I'm just trying to on the new side, are those kind of again new tenants to the market? Is that part of the positive absorption trend that we're seeing or is that just new to your portfolio and these tenants are in effect just kind of playing musical chairs right now?

Well it's a bit of both but I wouldn't call it in every instance where a tenant is moving from one building, Steve, into another building musical chairs because many of you have written about the fact that there is a dirth of new construction and that ultimately there is a number of --- there will be and in fact is an increasing number of facilities that no longer meet the needs of tenants that are in them and they are moving out to, in some cases, a flight to quality, in some cases it's because they've seen opportunity to step up into an asset that's better suited for their uses.

And with the healthcare types, sometimes that's because of changing demographics. The facilities don't work for them that they've been in for some period of time because of codes and/or other situations, so it's not for that portion of tenants, that are moving from one building to another it's not always musical chairs.

Okay, John, could you just comment a little bit about the occupancy drop in, I guess, the LA Ventura County bucket? I know you took the one Boeing building that was I believe 100% leased but otherwise the occupancy still would have dropped I think over 200 basis points from June?

Yes, Steve, this is Jeff. As you pointed out the Boeing was a big chunk of that but we did get a little bit of space back sort of scattered from Long Beach to West LA on just lease expirations that we did not renew.

Okay, so no particular trend?

No. It's just a couple lease expirations and various buildings like Long Beach or West LA, so I don't think anything that's a trend. Just the way the leases rolled.

And then John, can you just talk a little bit more about the two sellers, not necessarily specific but I guess in today's environment, I guess I'm maybe surprised there would be a lot of off market deals just given how much money seems to be chasing product today, so I just don't know if you can offer us any other color about motivations behind these? Do these need to get done quickly or just what could you offer on that score?

Well, I think that you hit on it right there. In both cases they wanted absolute certainty, they wanted to get done quickly. They didn't want to go to market. In one case, we had initiated conversations with somebody who knew the folks that owned the building because we said we would like to buy more in this particular area. They then brought us together. In the case up in Bellevue, similarly a group of individuals own the asset.

Let's just say that I think they are inclined to sell in 2010 more than in 2011 for personal reasons and they wanted to make sure that they had a buyer that would complete that and not horse them around and we've been looking in these areas and this building literally is the only building that Microsoft doesn't own in their campus and there's a new $30 million on/off ramp or rather freeway overpass that's all beautifully landscaped and so forth that connects this building right into the heart of Microsoft's campus and so we've been looking up there and saying, boy, if that building ever comes available, a broker who knew the guy introduced us and we were able to sit down and strike a price.

Okay, thanks. That's it for me.

You're welcome.

And your next question comes from the line of Michael Bilerman of Citigroup.

Thanks, it's Josh Attie with Michael. For the acquisitions are you assuming any secured debt with the properties?

No.

And can you remind us what the target leverage is for the Company?

Well, we've been in the sort of mid to high 30s, low 40s for our entire history and I think it's probably in that range.

And just lastly on 100 First Street to get to 94% occupied, are those leases already signed or do you need to lease up that building? Is there any incremental costs related to that?

Those leases are signed.

So it's already in place and there's no incremental cost?

Right.

Okay. Thank you.

And your next question comes from the line of Mitch Germain of JMP Securities. Please proceed.

Congrats on the quarter, guys. In terms of 100 First, what's the commencement dates of taking the asset from 76% up to 94%?

The tenant is expected to move in in mid next year and start paying rent early the following year.

Okay, great, and Tyler or John, could you just give some heads up on your plan with regards to the El Segundo asset?

Well we're under a major renovation right now. We had already done that to the building that DirecTV is largely --- the two buildings that DirecTV in along with some other tenants, we'd done those a couple years back, and so we're similarly improving the third building, the 2260 building plus redoing the plaza areas and so forth to modernize those and from a leasing standpoint, we have a number of proposals out ranging from the entirety of the building to floors within the building.

Great. Thanks guys.

You're welcome.

And your next question comes from the line of Michael Knott of Green Street Advisors. Please proceed.

Hi guys. Tyler, can you just remind me again what the price per pound was on the two acquisitions? I just want to make sure I caught those.

On 100 First it was $410 a foot and on the Seattle property it was $377 a foot.

And the Bellevue property is a new project, newly developed? Did I catch that right or did I miss that?

The building was built in 1998.

Okay, thanks for that. And then with respect to the possibility of asset sales, can you just give us a little more color on how you would think about it, is there a particular market or product type that you would consider exiting or just any color that you can provide on that?

Well I don't want to get into too much color for strategic reasons with regard to some of the tenants that are in there, since in some cases there's ROFOs and in other cases they don't have any rights but it's disruptive.

But let's just say that assets that are -- how do I describe this so I don't get anybody else in trouble with any of our tenants. If something is leased for the next 15 or 20 years and we don't see that it has a lot more upside other than cap rate compression, if we're comfortable with the cap rate today that's probably a good candidate.

If there's something for other reasons we don't feel has a strategic purpose like some of the little buildings that we acquired in a portfolio years back that are up in northern Orange County and so forth, those would be good candidates. If --- so, you kind of get the drift.

We've got a number of those, the former category in the portfolio to the tune of several hundred million dollars and the question is, we'll do a very disciplined disposition. I don't think we'll throw everything on the market at once.

Okay, and then just in terms of rough potential size it could be maybe as high as $200 million or $300 million but not necessarily that high? Is that kind of the way we should think about it?

We'll provide more color on that on the next call. I don't think we want to give a specific amount out right now.

Okay, fair enough, and then, Tyler, I know you said you aren't going to raise any additional equity in conjunction with these deals given that you did earlier this year but I forget what you may have said in the past about installing an ATM program? Is that something that you would think about?

We've thought about that over time. We haven't done that yet. We sort of like the idea of just going to market when we have projects to talk about but that isn't to say we wouldn't do it. But we haven't made that decision yet.

Okay, and then last question for me. John, can you just talk about maybe your asset management and leasing strategy for the two new markets this year including, I guess, Bellevue, assuming that deal does close, can you just talk about how you intend to staff and manage those markets?

Yes. In Bellevue, it's a triple net situation with tight controls like we would put on a triple net, so Microsoft does that themselves, we obviously have to overlook it.

They have a -- one of the things we're really impressed about that asset is it looks brand new. It literally you could eat off any surface. It's that clean and that well maintained and it has a very important group that's in that particular asset, so I don't know if that's the way they treat everything but certainly the way they treat this building. But again it's triple net.

And our play there is basically we think we'll move the rent up very substantially and ultimately over time we'll see how successful we are in increasing our portfolio there.

We're going to be very selective. We don't have any dollars that we've allocated to the northwest or otherwise but the overview of all of that of course ultimately gets back down to Jeff. That will be handled. We're going through that right now. It's whether we're going to handle that through an asset manager -- a senior asset manager in San Francisco, or it's two hours away, or whether we'll handle that through the LA office here.

As regards to the San Francisco, which is the more --- you know larger portfolio, and where we have now 1.2 million square feet subject to closing 100 First, we acquired through 303 Second Street a very good asset manager and a very good staff that really understands San Francisco, really understands that specific building but also had been involved in a company that provided asset management service to a variety of buildings in his former life.

We are deliberating with the person that's the asset manager on site of 100 First. More to come on that. And then right now, we're in a situation where we have an individual here that's responsible for our overall asset management activities, John Fucci, riding herd on those projects. And we're deliberating as to when we will hire a -- call it a regional Vice President, we've already begun some interviews. We'll keep you informed as we make our decision.

It's not an imposition to us at this point but if we continue to grow in that market and we intend to or hope to, then we think we need to have a Vice President, a more senior person of asset management on the ground.

Thanks for that color. Appreciate it.

You're welcome.

And your next question comes from the line of [Chris Caton] of Morgan Stanley. Please proceed.

Hi, good morning. My question is on 100 First. A question about your ability to kind of maintain occupancy there. What lead that to get down to, call it, 75% leased? I think if I'm looking at some correct data here it looks like six of the top 10 floors are the vacant ones, especially as activities at Transbay Terminal heats up over the next few years?

Well one of the things we liked about this asset is the folks that own it bought it at a time that turned out to be probably the worst possible time to buy an asset there, so that they really had to suffer through the releasing of it in a very, very uncomfortable market and they were able to do so.

And those floors that you mentioned, the building is now 94% leased and they lease those floors at very low rates during the downturn so we think there's tremendous upside once those rates --- or rather once those leases roll.

With regard to the particular asset there's really no material vacancy that comes up. I think it's a total of maybe 30,000 feet or so that comes up over the next five or six years. And while the Transbay Terminal is well under way, we like that because when you have construction so forth, you have disruption. The construction is supposed to be done in five to seven years.

We think that the -- is going to be wrapped up and they will be working on the park and so forth seven years out. We think that this asset gets the benefit of being well leased during that period, comes on stream just the right time when one can really see that you've got this incredible multi-modal transportation system right next door plus a 5.5-acre park plus all kinds of new amenities. We think it transforms the marketplace right there and particularly with regard to the adjacencies to this asset, which is right next door to Transbay and to just a world class location. We think we'll move the rates up very nicely.

So to what extent did you have to kind of get bullish in your underwriting either through some of the market color you gave about rent potentially already rising SoMa or --?

Well, yes. If you taken a look at the office markets, I think it's CBRE that just recently came out and they put forth various rent inflation index for Manhattan, Chicago, Dallas, Los Angeles, San Francisco, Seattle, etc., I can tell you that the underwriting that we had was far more conservative than what that analysis puts forth. We think we were very conservative.

And are you, given the movement in market rents, are you increasing your expected rent in 303 Second for the remaining vacancy of there or are you holding at current levels?

Well we're starting to push the rent, as I mentioned in my comments that the CAC group or rather it's Jones Lang LaSalle reported 7% increase quarter-over-quarter in rents in the tech media area that 303 is located. So our intent is to move rents very -- up as far as we can and we have some strategies for that.

In addition to that, we had in our budget when we bought it money to reposition the plaza and the retail and we have a plan that we've worked on with [Gensler] on that that we're now getting approval for. So we think that there are a couple of different ways to improve the economics of 303 beyond just moving the rents up. Obviously there's leasing, there's repositioning the retail, there's also some parking plays that we're pursuing.

Thanks, and then just one quick question on deal metrics for 100 First. I think I heard it was the stabilized seven yield, it that a cash and how long does it take to get to that seven yield?

It is cash and as I mentioned the tenant moves in in the middle of next year and then starts paying rent the following year so it really --- it kicks in when the tenant starts paying rent.

So like around January 1 in 2012?

Yes.

Thank you.

And your next question comes from the line of Anthony Paolone of JPMorgan.

Thanks. On your guidance for FFO for the rest of the year, it seems like at the low end you'd have about a $0.05 roll down from your third quarter level and so given the expectation that occupancy is trending higher and you've got some accretive deals here, just wondering what would cause you to come in towards the bottom?

Well we have a full quarter of the new bank line, I think the interest expense will continue to rise a little bit into the fourth quarter and that's the primary reasons.

As I pointed out we have some acquisition costs from these deals that will be hitting in the fourth quarter which will be partially offset by the accretion from these properties but there's a little bit of that as well.

And then just on the deal pipeline, you may have touched on this but just can you break out for us geographically where you're seeing transactions or where the most of --- where most of the activity is occurring?

Could you repeat that, this is John Kilroy. I didn't hear the first part.

Yes, just in terms of your deal pipeline and what you all are looking at, how does it break out geographically?

Well, it depends on how big of the pipeline you look. Chris and his guys, Chris Corpuz, our Head Acquisitions who's in the room and his people obviously have on computer a huge number of things they track. And then we have very specific areas and assets that we obviously have a much greater interest in.

And we are tracking a number of things in San Francisco. We're tracking a number of things here in Los Angeles, and we're tracking some things down in San Diego and then we obviously tracking things up in the northwest as well. But it's -- I don't really want to throw out a number because if you add all of that up it's billions and billions and billions of dollars and obviously we aren't going to buy billions and billions of dollars.

We've --- as we've -- at this point, we have signed six letters of intent to buy assets. Four of them we've closed on. Two of them we're now hard on so we're very disciplined in what we buy and how we go about it. We've pushed back from the table a number of times, a far greater number than six, when either the pricing was too rich or there was something about the asset that became apparent, didn't make it one that we wanted to own.

But there isn't anything geographically like you're seeing most of your activity in San Francisco for instance or somewhere else?

Yes, we're consolidated right now to the West Coast and the area that you've seen us announce up in the northwest is an area we like. Right now we're very focused in the Bay Area in San Francisco and then of course here in Southern California, we're not looking at any markets that we're not now in in the Southern California area.

Okay, thanks.

You're welcome.

And your next question comes from the line of Steve Boyd of Cowen & Company.

Hi, yes. You provided the going in yields for the acquisitions and talked about the below market nature of the leases. I was just curious what type of IRR you think you've underwritten these to?

We're sort of in the mid 9% range.

Mid 9%. And what type of terminal cap rate do you provide, for an increase or --?

No, in fact our terminal cap rates are above the acquisition cap rates.

Okay, and the other acquisitions that I guess you guys have signed letters of intent on, would it be a similar type of IRR?

Yes, roughly.

Okay, thank you.

And your next question comes from the line of Dave Aubuchon.

Good morning. A question on the tenant that is moving into the first plaza building to take it from 76% to 94%, assuming that's one tenant, it's 80,000 square feet. Are they coming from the market, another building or are they sort of internal growth within that particular asset?

First of all, it's multiple tenants.

Okay.

And where are they coming from, Chris?

Most of the tenants that we see at 100 First are not coming from outside the market. They are coming from within the Greater San Francisco area.

And that particular submarket as well or just scattered across the city?

It depends on the lease and the floor, but I'd say generally, it's scattered from around the city.

Okay. John, just sort of dovetailing on a prior question about the acquisitions and where they're coming from. You've obviously been pretty successful at closing deals in San Francisco, Seattle, San Diego, Orange County but just sort of interesting that LA is just not a market where you're gaining market share. Other office REITs have been acquiring assets within that broader market.

Is there a particular reason why you're not finding deals you like within LA?

I can't get into how other folks underwrite things. We're very -- I've been doing this a long time, and we don't have a clearer crystal ball than anybody else but I will tell you that we are very rigid in the way we think about property.

If we don't like the plant or the equipment or we don't feel that it is going to stand the test of time either because its design or because something involved in the way it's constructed, it doesn't matter what the yield is unless we can fix it. It doesn't matter what the yield is, we're not going to buy it.

If it is a yield that doesn't meet our criteria, we aren't going to buy it. If it's a location we think it's a tweener and we think that it's going to struggle in a more difficult market we aren't going to buy it. So by definition, we put ourselves in a position where we aren't going to be able to play on those kinds of assets.

Now, there are assets that have been bought that we have looked at and either came to the conclusion we didn't like it for one of the reasons I mentioned or we didn't like it because of where the pricing got. And I'll freely admit we have been wrong multiple times where other people saw much greater value than us. We didn't see it and they were right and we were wrong.

On the other hand, if you look back in the bubble years there were a lot of people that saw a lot of value that evaporated and we were right and I guess that's what makes a market. Don't think that we won't buy in the LA area. I'm not putting a --- I'm sort of putting a line around downtown LA and saying we don't even look there.

Right.

Don't think that we won't buy if we find the right asset. It's just that we're very disciplined and very thorough in our underwriting and when it doesn't meet the test, it doesn't get near the hoop.

And how close are you do you think from transitioning from the stabilized sort of strategy to more of a value add and would that probably depends by market? Is there any market that you think maybe you're willing to take a little bit more of an aggressive approach?

Well we do like, as you know we've had a long history through the evolution of technology type tenants. That's how my dad started the Company after World War II.

And if you look at what technology companies are, they're the collaborative workforces and what -- you see the same kinds of layout, the same kind of improvements, the same kinds of people frankly and whether it's entertainment, whether that's motion picture, whether that's music, whether that's the talent scouts as you do in the cloud computing and the HPs and the [Semetechs], all of these different hard core technology companies, they all occupy space that looks kind of the same. And it can be in new buildings or it can be in older rehab buildings.

Of course Kilroy has a particular expertise with regard to rehabs and with regard to ground up construction, and we like and understand the technology type companies.

So where we think there are some --- where we see some opportunities or the potential for opportunities are in some of the markets that we're now in where we can acquire an asset and renovate it to a fashion that makes sense economically and as an appropriate risk adjusted return because it's not just buying something that's already shiny and fixed. And doing that for those types of industries that are on the go.

You're not going to see us going out and buying a building that's vacant in some secondary market that is going to be a long way off before they have the job growth that will fill that asset. It's just not something that we're looking at or focused on at all.

So if you think of the areas that we're in and you think of technology companies where there's some visible demand, you would be correct in thinking that we're looking in those areas.

And I might add that in San Francisco, and I made note of this in my comments, that the CAC Group who is very involved, one of the premier office folks in San Francisco, put together an analysis and there's basically a million square feet right now of tenants in the SoMa area, greater SoMa south of Market area in San Francisco in the tech world that are looking for space.

There's already a million square feet of deals that have been done this year and it's projected to be the biggest year ever for those types of tenants. Those people are sort of right in our wheelhouse.

Okay, very helpful. Thank you. Just two more questions. Tyler, you mentioned that you want to close these acquisitions, it looks like they will close by the end or middle part of next month. Should we assume, markets willing, that you want to get a unsecured debt deal done before the end of the year?

Yes, that's likely, yes.

Any particular term you're looking at or eying?

Well we did a 10 year deal earlier in the year and we did a seven year deal even earlier than that in the year so a five year deal might make sense at this point.

Okay, and then last question is, the note receivable that you've been carrying for a while went away. That just got paid off?

Yes.

Okay, thank you.

And your next question comes from the line of [Michael Eilerman]. Please proceed.

John, just a question that's on the market south of market and obviously just having toured it with you recently, it's pretty excited. How did you evaluate the potential risk just in terms of public funding going forth to fund Transbay and then also the anticipated new developments that would come into the market?

Well, let's deal first with the reason Transbay was so promoted by the city because they see that becoming the center piece of the 21st Century San Francisco. That's why that project got such push over the years from the city.

With regard to the $1.7 billion funding that is required for that first phase, first let's describe what the first phase is. It is the multi-modal station and at its various levels and the retail and so forth. It's within that and the park that's above it, the roughly six acre park that's above it. The funding for that, Chris do you want to address?

Sure, sure. As is the case with the most projects of this scale, funding comes from a number of different sources. There's local, regional, State, and Federal money.

At the local level let me just count it up here. It's about $140 million and they come from sources like Prop K, the San Mateo County Sales tax, AC transit, then at the regional level, the State level and the Federal level with the last $400 million to top it off at $1.7 billion having come from the Stimulus Act.

But that is funded; correct?

That's funded.

So with regard to how we see that as a driver, I think that's where you're going and our interest in that area, this literally will be, it's unprecedented in the West Coast.

You all are in New York or Chicago, Boston, etc., have your own different forms of multi-modal transportation. On the West Coast, I guess LA used to when it had the old red cars back in the 1930s in San Francisco, obviously as a city that has always encouraged different modes of public transportation, in fact most office buildings don't have any parking or very little parking and most people get to work by some form of multi-modal transportation which can be anything from a bus to a light rail to heavy rail, the BART systems, etc., even ferries across the water.

This particular Transbay Terminal will be the largest concentration of different modes of public transportation in the western United States. It is truly one of the major infrastructure projects of our time, at least with regard to transportation.

It will have all of the amenities that flow from that with regard to retail restaurants, etc., so this is going to become the epicenter in our view of San Francisco and it's something that tenants are very excited about. In fact some of the tenants that have located in that area and other buildings recently because of knowing that the Transbay is going to go forward had made the decision that, gee, this is where they need to be.

Now BART also is in very close proximity to 100 First. So we looked at this as an opportunity. We literally went around and looked at all of the buildings some of which have ownership that aren't going to sell. Some might sell and we've been trying to sort of pry some things loose.

We were successful on this one. The fact about this particular building that I really liked is that if you think of a building having four sides this building has a side on Mission which is nice exposure, it has one that is facing on First which is its front door and presently -- or up until they are tearing it down right now, it literally looked across the street at a 1940s, 1950s vintage building that was a Continental Trailways building with all of the attendant sorts of folks that hang around those terminals. And on the south side of the building, it had an old freeway overpass that hadn't been used in years where you literally had homeless people living underneath it.

Those are now being torn down. So just with that being -- those two things being torn down, those two horrible adjacencies, the building will go from having two wonderful adjacencies to four wonderful adjacencies in very short order.

Then it will go to having -- being at ground zero, I shouldn't use that term, at the epicenter of the new transportation nucleus, and this park and what not, I think it's going to become one of the most sought after buildings in the city.

That's helpful. And just on the Boeing building now, El Segundo, you've put in about $51 million into that building, historical costs for the 10-K and you've targeted now here another $40 million of redevelopment, so call it in at over $90 million or $300 a foot. Does that math make sense from a return perspective?

Well the buildings were built back, John, when were they built?

Early 1980s.

So you're talking about the original basis of when the buildings were built?

Yes, your original basis is $50 million, so you know you are going to put another $40 million into it. What's going to be the return on new capital versus return on total?

Right. The incremental costs of the development is, as you point out, about $40 million. Some of that -- a lot of that is TIs and leasing commissions to retenant it, almost half that. And so the incremental redevelopment cost is a portion of that $40 million. But the depreciated basis as you saw is about $9 million because the buildings were built 30 years ago.

I'm just wondering how many more of -- is there a substantial more within the portfolio that -- because this is still yielding reasonable on cost. So I'm just trying to figure out if there's other things that we need to be mindful of where you have to put in substantial capital to keep a return?

This is John, Michael. I don't --- I mean there could be on some smaller ones but nothing to this level. What we're really doing here is we had repositioned two of the buildings that are --- two of the three buildings in the complex and that basically they are occupied.

One is an entirely occupied by DirecTV. That's about 100 some thousand feet and the other is about --- a twin buildings, 300,000 feet and DirecTV occupies about 200,000 square feet.

And what we're doing is not only repositioning the older building, it's not older but it looks older, 2260 building, to bring it up to speed to where -- what we did for DirecTV and the adjacent essentially twin building of 2250, and then have the TIs and so forth. But we are also repositioning the courtyards and the plazas and all of the rest because we think we are going to be able to drive the economics of the entire complex up pretty substantially.

And I can't really get too much further into that but let's just say that we're having very good discussions with folks.

Thank you.

You're welcome.

Thank you for your questions, ladies and gentlemen. I would now like to hand the call back to Management.

Thank you for your time today and your interest in KRC.

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