Kilroy Realty Corp (KRC) 2010 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth-quarter 2010 Kilroy Realty Group earnings conference call. My name is Francine, and I am your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions).I would now like to turn the presentation over to your host for today's call, Mr. Tyler Rose, the EVP and CFO. 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 and 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 an updated look at our key markets. I will follow John with financial highlights and our initial earnings guidance for 2011. Then we'll be happy to take your questions. John?

Thanks, Tyler. Hello, everyone. Thank you for joining us today. The fourth quarter was a strong close to a very good year for KRC. We maintained significant leasing momentum, continued to move up our occupancy rate, and acquired three office properties, and we are moving into 2011 with a broader geographic footprint, a more diverse platform for growth, and the financial resources to support that growth.

Fourth quarter leasing increased almost two-fold over the prior quarter. We signed new or renewing leases on 850,000 square feet of space. With that strong year-end performance, we have leased a total of 2 million square feet for the second year in a row, and as we mentioned at our January 13 Investor Day in San Francisco, at year end 2009 we had 22 vacant buildings in our portfolio. And now we have four that are currently unleased. Our leasing success boosted occupancy for the third consecutive quarter. We ended 2010 with stabilized occupancy at 89.1%. That's up from 86.4% at the end of the third quarter, and more than 630 basis points higher than where we started the year.

This momentum has continued into 2011. We entered the year with stabilized portfolio at 92% leased, and with roughly 400,000 square feet of LOIs outstanding. Given the level of interest we are seeing from prospective tenants across most of the portfolio, we expect further gains in occupancy this year. In terms of acquisitions, we continue to capitalize on opportunities in the fourth quarter to purchase well-located high-quality assets with good economics at prices below replacement cost. We completed three transactions, totaling 692,000 square feet, for a total purchase price of $268 million.

We reviewed two of these acquisitions on our last call. 100 First Plaza in the South Financial District of San Francisco, and the Overlake Office Center in the Redmond area of greater Seattle. In November, we acquired the third property, Liberty Station, a 104,000 square foot office building located in the Point Loma sub-market of San Diego.

The LEED Gold Building was completed in 2009 and is 95% occupied. The property is adjacent to 125 acres of park and open spaces, a large retail center near the San Diego airport, and SPAWAR, the large defense complex. The purchase price was approximately $31 million, and the property has initial yield of 7.8%.

Since the beginning of 2010, we have made a substantial commitment to growth via acquisitions. Through December, we invested $700 million to acquire ten office buildings in eight individual transactions. These acquisitions added more than 2 million rentable square feet to our stabilized portfolio. They increased the value of our asset base by approximately 30%, our square-footage base by roughly 17%, and our NOI by about 22%. This broadened our presence in some of our existing Southern California markets, and they extended our franchise into two highly attractive west coast markets, San Francisco and the east side of Seattle.

We anticipate additional acquisition opportunities in the year ahead. In fact, we are off to a good start in 2011, and just last week closed on a 91,000-square-foot office building at 250 Brannan Street in the South Financial District of San Francisco, for a purchase price of $33 million. This is a three-story building that is currently 77% leased to two tenants, tech companies Adobe Systems and the data mining firm, Splunk, through 2013. We purchased the property for roughly the loan amount, which matured on January 31. The cap rate with 77% leasing is 6.8%.

Moving to the Company's balance sheet, we completed our second issue of public debt in the fourth quarter, successfully placing $325 million of five-year senior unsecured notes at an annual interest rate of 5%. This transaction is one of many steps we have taken at KRC that has broadened our sources of capital, improved our credit profile, lengthened our debt maturities and strengthened our overall financial position. All in all, we have made significant progress over the last year. And we expect to make a good deal more progress this year.

Most of our sub markets are exhibiting signs of recovery, albeit at different rates. We remain focused on our leasing program, and in several of the Company's markets, we are seeing the entry of larger tenants looking for significant blocks of space. We are seeing the early signs of being able to push rents in certain locations, and we expect our occupancies to continue rising.

From a portfolio growth perspective, we expect overall industry acquisition activity to accelerate, and the field of potential buyers to expand. We believe our strong financial position, deep relationships and contacts, thorough due diligence progress and vertically integrated platform give us a competitive advantage in bidding for assets and we will continue to pursue acquisition opportunities in the best West Coast markets with both energy and discipline.

We are also preparing for the day when development once again makes economic sense. In our San Diego sub-markets, we believe demand has turned a corner, and large tenants are once again indicating some interest in opportunities to pre-lease new development. We will continue to push forward with entitlement efforts to ensure that we are in step with evolving market needs, and in addition, we expect to position the Company, just as we did in San Diego when we entered that market over ten years ago, to take advantage of development opportunities in the markets we have recently entered.

In support of all of these activities, we remain committed to preserving our strong financial position and operational flexibility. In the face of persistent uncertainty, we believe that financially strong and operationally agile companies will outperform. We will continue to manage our balance sheet and leverage our management team, and we will continue our strategy of capital recycling, disposing of non-strategic assets to reinvest the proceeds in new acquisition and/or development opportunities.

As I mentioned earlier, KRC sponsored an Investor Day last month, during which several members of our management team offered in-depth reviews of our Company's markets, our leasing program and results, our financial position, and our growth strategies. For anyone who did not attend or listen to the webcast, the replay of that presentation is available on our website.

To further bolster our management team, we are pleased to announce that Eli Khouri has joined us as Executive Vice President and Chief Investment Officer. Eli has extensive investment experience in West Coast commercial real estate, dating back to the early 1980s, and will be responsible for our acquisition activities.

From 1991 to 2001, Eli served in various investment capacities at Spieker Properties, including Chief Investment Officer, where he was involved with the acquisition and development of over $5 billion of assets, as well as managing its disposition and capital recycling program. In 2001, Eli was part of the management team that orchestrated the merger of Spieker into Equity Office Properties. In 2002, Eli co-founded and served as Managing Director of Broadreach Capital Partners, a private real estate investment firm focused primarily on Western US commercial assets. Raising discretionary funds from numerous endowments, foundations and other institutional investors, Broadreach has managed approximately $3 billion in investments since 2003.

Eli joins KRC with intimate knowledge of the markets and the assets within our operating footprint. Chris Corpuz, the Company's Executive Vice President of Strategic Initiatives, has done a terrific job for us over the past year as KRC has become an active acquirer. He will now shift his responsibilities to focus on new strategic growth initiatives.

Now let's take a closer look at our individual markets. We continue to gain confidence that our San Diego sub-markets are turning the corner. Overall, the region experienced positive absorption in every quarter of 2010. Job growth remained flat throughout the year, but is projected to begin growing again in 2011. We are seeing a solid pipeline of demand from corporate users for large blocks of space, and increasing demand for KRC's product across the board.

San Diego represented 40% of our total leasing in 2010. Our portfolio occupancy increased 960 basis points, from 76.8% at year-end 2009, to 86.4% at year-end 2010. The San Diego portfolio is now 89% leased. We have seen improvement in Del Mar, Sorrento Mesa, and I-15 Class A sub-markets with demand coming from health care, software, technology, life science, defense industries, amongst others.

An example of a significant fourth quarter transaction for us was the execution of a 103,000 square foot lease for an entire Sorrento Mesa property. We had interest from two potential tenants, and were able to strike a deal with Sharp HealthCare for a term of 20 years. We have previously expanded our entitlements on this property to include medical office, which really paid off for us. Sharp plans to invest approximately $20 million in our building while our TI package for the lease is just $10 per square foot.

Moving north to Orange County, the office market there, which had suffered 13 quarters in a row of negative absorption, finally saw the beginning of a turnaround, and had its second consecutive quarter of positive absorption and net positive absorption for the full year. While rents remain flat, we are seeing modest demand and job growth, largely as a result of regional business expansions.

The industrial market also experienced strong fourth quarter absorption, and vacancy rates trended down, but we expect leasing rates to remain soft in the near future. Our Orange County industrial portfolio is now almost fully leased at 97%. Our combined office and industrial properties in Orange County represented 37% of our 2010 leasing activity, and the occupants for these properties increased 900 basis points from 85% at year-end 2009, to 94% at year-end 2010.

In West Los Angeles, real estate markets remained somewhat tepid, reflecting the area's weaker recovery, and job growth relative to some of our other sub-markets. This is visible in both vacancy and in rental rates. The good news is that we are seeing some positive signs with sublease vacancy rates continuing to drop for the fifth consecutive quarter. Additionally, we were monitoring media, gaming and other incubator firms that have been looking to move from secondary markets back to West LA. About 20% of our 2010 leasing took place in our Los Angeles properties. Overall, our portfolio of occupancy in the region increased from 89% at year-end 2009, to 90% at year-end 2010, and the portfolio is 90% leased.

Now let's move up to northern California where San Francisco experienced a second consecutive quarter of positive absorption, and our South Financial District sub-market is posting double-digit rent growth. There is continued strong demand from technology and media tenants. Over the past year, technology companies have signed leases on 1.3 million square feet of space, which is one of the biggest years in recent history. The vacancy rate in the South Financial District dropped about a point from last quarter to 11.7%.

Our portfolio of occupancy in San Francisco was 84% at year-end 2010, down from 89% at the end of the third quarter, due to the addition of 100 First Plaza, which is 76% occupied, but 94% leased. Overall, our San Francisco properties are currently 95% leased. We continue to capitalize on strong demand in this market, and moved our occupancy at 303 Second Street from 89% when we acquired the building last summer, to 96% leased today.

Moving further north, the East Side sub-market of Seattle, where we have recently taken a market position, experienced a third consecutive quarter of positive absorption, technology tenants are driving demand in the area clustering near Microsoft's campus, and the vacancy rates in the region are trending down. Our building is 100% leased and occupied.

That's an update on our market conditions and activity. In summary, 2010 was a solid year for KRC, and we see more opportunities on the horizon.

Looking back at last year's fourth quarter conference call, we said that 2010 would be a transition year for the Company. We said we would begin evaluating acquisition opportunities, and at the time we had no acquisition pipeline. We ended up acquiring 2.1 million square feet of top-tier assets at meaningful discounts to replacement costs, and expanding our franchise into Northern California and the Pacific Northwest. We forecasted year-end 2010 occupancy at 86%, and we ended the year at 89%. We said we would continue to manage our balance sheet and we received investment-grade ratings, raised equity, and completed two bond offerings.

Looking forward, we continue to gain traction in our leasing program, and hope to take the lead this year in moving rents up in our markets. We anticipate additional acquisition opportunities as our pipeline continues to grow. And we expect to recycle capital through an active disposition program. We are operationally prepared to manage our growing market presence, and financially positioned to expand it further. And we are now taking a serious look at emerging development opportunities, taking steps to ensure that we have the entitlements and the other resources in place to move ahead as opportunities arise.

The energy level around KRC is very high. We remain very focused on our goals, and we are enthusiastic about the year ahead. As always, we appreciate the support of our shareholders. Now I will turn the call over to Tyler who will cover our financial results in more detail. Tyler?

Thanks, John. FFO was $0.54 per share in the fourth quarter, and $2.05 for the year. As John mentioned, we ended 2010 with occupancy in our stabilized portfolio at 89.1%. That compares to 86.4% at the end of the third quarter, and 82.8% at year-end 2009. By product type, industrial occupancy rose to 93.9% at year-end in 2010, from 90.6% at the end of the third quarter, and office occupancy increased to 87.5% from 84.8% at the end of the third quarter. Overall, our properties are now 92% leased.

Same store NOI in the fourth quarter increased 6.3% on a GAAP basis, 1.3% on a cash basis. For the full year, NOI was down 1.2% on a GAAP basis, and 3.1% on a cash basis. The improvement in our NOI over the past 12 months reflects our rising average occupancy.

Looking more closely at our recent lease terms, office rents on leases that commenced during the fourth quarter declined 4.1% on a GAAP basis, and 10.1% on a cash basis and industrial rents were up 35.3% on a GAAP basis, and 38.4% on a cash basis. For the leases that commenced during the year, office rents decreased 2.3% on a GAAP basis, and 9.5% on a cash basis, and industrial rents were off 26.5% on a GAAP basis and 31.7% on a cash basis. Looking at the 850,000 square feet of new or renewing leases we signed during the fourth quarter, office rents on these leases were up 1.9% on a GAAP basis and down 4.6% on a cash basis, and industrial rents were down 25.3% on a GAAP basis and 37.3% on a cash basis.

By region, the rents on leases we signed in Los Angeles were up 19.9% on a GAAP basis, and up 8.6% on a cash basis. Rents in Orange County were down 25.8% on a GAAP basis, and 35.9% on a cash basis, reflecting the softness in industrial rents. While industrial rents have fallen on a pro forma basis, the percentage of KRC's NOI related to industrial properties is now down to approximately 8%. Finally, in San Diego, rents on leases we signed during the quarter were down 8% on a GAAP basis and 12.1% on a cash basis. With regard to the 400,000 square feet of LOIs, three-quarters -- are office leases and one-quarter are industrial leases, they are split half-and-half between new and renewal.

We estimate that rent levels in our overall portfolio are approximately 10% over-market, our remaining lease expirations in 2011 totaled about 716,000 square feet, or roughly 5.8% of our portfolio. During the fourth quarter, we sold three small non-core Orange County properties, totaling about 158,000 square feet, for total proceeds of just under $16 million. As John mentioned, we are continually evaluating our portfolio for opportunities to recycle capital and subject to our acquisition and development activities, we anticipate the dispositions to significantly increase.

Turning to the balance sheet, during the fourth quarter, we completed a $325 million unsecured note offering, with a term of five years and an interest rate of 5%. We used the proceeds to fund our most recent acquisitions and pay down our credit line. Last month we closed on $135 million secured mortgage on our 303 Second Street property in San Francisco. The mortgage has a 4.27% fixed interest rate, and matures in seven years. We used the proceeds to pay down our credit line, which as of today, stands at $75 million.

As I mentioned at our Investor Day, it's worth pointing out that we believe there are several areas that will add to KRC's shareholder value now, and over time. The first is acquisitions, where we are taking advantage of pricing inefficiencies to acquire high quality products at attractive prices. The second is development, where $100 million of development could add $0.05 or $0.06 a share to the bottle line. Third is the conversion of free rent to cash rent, which will help us improve our dividend coverage, and fourth is lease-up, where we can generate significant earnings to the bottom line by moving our occupancy back to historical levels. These growth initiatives will be key to our success in 2011 and beyond.

Before reviewing our 2011 guidance, let me spend a minute on G&A. G&A was down significantly in 2010 from $40 million in 2009 to $28 million in 2010, or a decrease of 30%. If we exclude Dick Moran's 2009 severance costs of approximately $7 million, our 2010 G&A was down $5 million, or 15% year-over-year. For 2011, our current budget is essentially the same G&A as 2010, but also assumes a slightly expanded staff to accommodate our growth. In an effort not to be an outlier in terms of the structure for our annual bonuses, we will modify the structure this year to more closely follow our peer group. Annual 2011 executive bonuses will be structured to allow the Compensation Committee of the Board to evaluate a variety of key factors and metrics, including absolute and relative share performance, FFO per share, acquisition, disposition, development and leasing performance among others, at the end of the year, and make a determination of [executive] compensation based on management's overall performance.

Now moving to 2011 guidance, given the uncertainties in today's economy, we remain cautious in our near-term outlook. I must also caution that 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 results in ways not currently reflected in our analysis.

Taking those caveats into consideration, our assumptions are as follows. Average occupancy of 91%, given the uncertainty of amount and timing as usual, we are not including any projections for acquisitions, dispositions and their related expenses. We assume that LIBOR will average 60 basis points for the year, we're assuming, as I say, total G&A costs will remain static at approximately $28 million. And finally, we are assuming the continuation of our dividend at the current level of $1.40 a share. Taking all of those assumptions together, our initial 2011 FFO guidance is $2.20 to $2.40 a share.

That's the latest news from KRC. Now, we will be happy to take your questions. Operator?

Yes, sir. (Operator Instructions).Our first question comes from the line of Jamie Feldman of Banc of America-Merrill Lynch.

Thank you. Tyler, just back to the comp plan quickly, you said $28 million, and that's flat year-over-year but in the 2010 number includes the severance? Is that correct?

No, 2009 included the severance of Dick Moran. So what I was saying is 2009 our G&A was $40 million. 2010 our G&A $28 million. If you take out Dick's severance out of the 2009 number, our G&A fell $5 million from $33 million to $28 million. There's no severance in 2010.

Okay. Then bigger picture, John, thinking about the acquisition market. We have heard several management teams thus far in earnings season talk about how they may be becoming net sellers or at least think being selling more than buying, given how pricing has come in. Can you give us your latest thoughts on that, and maybe what you are seeing different than they are seeing in your markets, that keeps you as a buyer?

Yes, Jamie. We said in our January presentation that was webcast -- and we mentioned this, I think, in the third-quarter conference call, that we at Kilroy sort of see three inflection points to the cycle. The first being what we've been doing this last year, buying what I am going to call Kilroy core assets, which are in the markets and so forth that we like and that are cash flowing, very little value-added activity, other than moving rents up over time.

I see now the second inflection point coming more quickly than we thought it would come, and that's where we are -- be buying not only a continuation of type assets you have seen us buy here in this last year, but also some value added plays, where we are seeing some very poorly-managed buildings, that have debt issues and what not, where we can go in and buy them and I think turn around the buildings very substantially.

So on the investment side, I see us continuing what we have been doing. I see over time that will become, just to pick a number, maybe it will be 50% of our acquisition activity for the year, where a value-added component in good markets will be the other component of acquisition and then flipping on to the other side, the disposition side, you will definitely see Kilroy be a seller, but not a net seller, but we definitely will be a seller of assets that are non-strategic and/or long-term leased, where we think we can convert that to a higher and better value through recycling the dollars.

Okay. Thank you.

You're welcome.

Our next question comes from the line of Suzanne Kim from Credit Suisse.

Hi, I just want to learn a little bit more of your AFFO components. When do you think you will start covering the dividend, and also is the $5.5 million that we saw last quarter in straight line rents, is that an anomaly? Should we view that as a good run rate for 2011?

Yes. I would say $5 million or so is a good run rate for 2011 per quarter. That's not an anomaly. It should be a little bit lower than that, but roughly $5 million or so per quarter. In terms of covering the dividend, it depends on lots of things, obviously, but how much leasing we do this year, but our numbers showing that we will be covering in the fourth quarter.

Great. Thank you so much.

And our next question comes from the line of Michael Bilerman of Citi. Our next question comes from the line of Sri Nagarajan of FBR Capital Markets.

Hi, thanks a lot. In looking at the leasing momentum, John, would you characterize that you are seeing a lot of new demand from tenants. Is that net new demand in the market, or is simply Kilroy taking market share as a better, well capitalized operator? Also, if you could kind of piece out the demand from various sectors and tenant sizes, that would be useful.

Okay, well let me deal with the first part, and then I'll turn over the second part to Jeff Hawken, our COO. In regards to net new demand we are seeing -- first to your question, is it net new demand or is it Kilroy because we have a higher capture rate. It's both. The thing we saw so much in 2008 and 2009 was a higher capture rate with not a lot of new demand, very little growth. The big change we have seen in this last year is the lion's shares of transactions that have gone on, that we have done, have had some growth component.

But there is net new growth going on, and just to give you an idea, in San Diego, which everybody knows is a big market for us, there are a number of major build-to-suits that have not hit the rent market or the occupancy market, because they are for projects that are being built. There is 180,000 square feet for a Pharmaceutical company. 275,000 square feet for the FBI. 200,000 square feet for an Education company and another 123,000-square-foot for a Life Science company. Then a Financial institution for 60,000 feet. That's 834,000 square feet of pre-leased buildings that have been transacted for in San Diego, most of which relates to net new requirements or moving out of obsolete buildings that could not be reconfigured to accommodate those people.

In terms of current requirements, just talking about them for a second, there is about 1.4 million square feet of transactions that we are working on with regard to some kind of development component in San Diego right now, with one, two, three, four, five, six, seven, eight, nine different tenants. We haven't made any of those, but none of those were in the market, and almost all of that is growth. None of that was in the market a year ago.

With regard to the occupancy aspect in terms of absorption, we have had, as we mentioned, positive absorption, with a full year and for each quarter in San Diego, for the last two quarters and for the full year in Orange County. There has been a little bit of erosion in occupancy in the west side and there's been a substantial reduction in vacancy and increase in occupancy in San Francisco.

So, the momentum that we are seeing now, and if my voice sounds a little more exuberant than it has been over the last four or five conference calls, it's because we have been talking about gaining traction for some time, Sri, as you know, and I really do feel with the exception of the West Side, that all of our markets right now, we have gained quite a bit of traction. We have not seen other than a few instances, the one that we talked about with the Medical company on the 20-year lease, where we've had pricing power. But I'm beginning to feel particularly on the larger deals, that we are going to see pricing power return, if this is anything like every other cycle I have been through.

Right. If I can quickly follow-up on the build-to-suit, it looks like they are picking up of activity there. Could you remind us on your One Paseo entitlement process and how quickly or how close you are to that, as well as perhaps I guess on the other sub-markets of San Diego?

Well, yes, in terms of the One Paseo project as we now call that, that's the property which we sold previously, the Seattle Office Center that we had a few years back and traded into the property that we bought from Pardee, that particular property is 23 acres. It's currently zoned for 500,000 square feet of office that we could build. And we have been working, as we have announced over the past couple of -- I guess the past year or two, towards a mixed-use project in which we would, we are hoping to have approval in approximately a year, whether that takes an extra quarter or so, who knows. We have made very good progress with regard to the City and with regard to the HOAs. And that project as it's now envisioned would be a similar component of Office space, three different phases of Residential, which will total about 600-plus units. And a 150-room Hotel. And about 300,000 square feet-plus of Retail. So we are making very good progress. We think we are going to have our entitlements in the first quarter of next year or thereabouts. And that would be a real home run for us, if we are able to pull that off.

With regard to the other part of your question, in San Diego, I mean, obviously we have some development opportunities and the property we bought up in Orange where we can do Medical office buildings and some other properties, but just looking at the development pipeline that we set forth in our supplemental, we have between, on a low between 2.1 million and 4.5 million square feet we can build. Some of that difference is the One Paseo project and others, just depends how much we build it. We have very little interest in Carlsbad Oaks, we have one or two people that we were talking with, but it's a slow cooker.

On lot eight we are talking with somebody, on Rancho Bernardo we are talking with two different parties, and our Santa Fe Summit Two and Three, we are talking with a player that is interested in potentially all of that or half of that. The total is about 600,000 feet. On lot two we are talking with somebody, on lot seven, we're talking with somebody in the context of it and the adjacent property that was formally occupied by Epicor that totals 172,000 feet, we have two tenants interested in that complex.

Then Orange County, as I mentioned, where we acquired the little building at -- I forget what the heck it was -- 999 Town and Country -- 100,000 foot where we can build up to some 700,000 or 800,000 feet of additional space. We are pursuing. It's a longer range objective, Medical office space there, because of the dearth of MOB that's available in that market. That's where we are in our development.

Thank you. That color is useful. I'll yield the floor and join by the queue.

Our next question comes from the line of Michael Bilerman of Citi.

Thanks. It's Josh Attie with Michael. Looking at the 2011 lease expirations, they seem concentrated in LA. Can you talk about those, and what you expect the retention rate to be, if there are any large known vacates and from a sub-market perspective, are those expirations concentrated on the west side at all?

This is Jeff. In terms of our expiration for 2011, in terms of the office piece, basically it's one large tenant that's out in the Camarillo area that we're currently negotiating with. So that's the majority of the space. The rest of the role is pretty small tenants, I think the next one is 29,000 and lower. It's a lot of smaller transactions.

I think our overall retention or rate projection for 2011 is in the, sort of similar to what we did in 2010, sort of the 55%, 60% range.

It sounds like it will be either really high or really low. If you keep that one big tenant in Camarillo, it will be really high, and if you lose it, then it will be probably lower than 55%?

Right. Or there's an option where they stay in part of the building. It can go many different ways.

And can you also talk about the long-term plans for the Orange County industrial portfolio? Do you consider those assets to be core, or are those assets all considered for sale?

They are not now considered for sale, but we are, as we have always done, looking at each individual asset in the portfolio and whether we think there is significant future value to mine or whether, to the extent that there isn't, is it an asset that's better sold or kept, and that analysis, we have a very thorough analysis that's been going on now for a couple of months. I'm not going to get into specifically what that translates to on each individual asset.

Let's just say Orange County industrial today, Tyler, correct me if I'm off here, represents somewhere in the neighborhood of 8% of the Company's NOI. There are some sites there that have some definite redevelopment opportunity and some value that are beyond industrial. But we may or may not do something with that portfolio that is more strategic. We are looking at that now. That's one of the reasons that we pulled Chris Corpuz back into the role of strategic initiatives, because we are looking at a variety of different things that could include the industrial.

Tyler, it's Michael speaking. I want to get clarity just on the $28 million of G&A for 2011, clearly in 2010 that included about $6 million of stock comp, the majority of which I think came from prior year plans, and if memory serves me it was like $4.5 million from old plans and $1.5 million from the current 2010 plan. I think you said that there would be changes in the way that things would be done. And the Board would look at it at the end of the year. I'm curious to think about, how does that split when you talk about $28 million for 2011, how does that split between cash, current plan and the burn-off of old plans?

It's complicated, I guess. The accounting for the current plan that I talked about, is a little different than the accounting for the prior plans because given that it's determined at the end of the year, you don't book the stock component during the year. So there will be less stock amortization in 2011 than there was in 2010. There is some burn-off in 2011 as well of prior year plans, particularly the 2008 plan is now burned off and that won't be impacting the 2011 plan. But then, of course, you have the 2010 plan that we just finished that will be impacting the 2011 plan.

There are layers of the 2009 plan that will effectively in the numbers. There's the 2010 plan that we talked about. But it will be less stock and more cash I guess to your point in the 2008 numbers -- I mean, in the 2011 numbers.

So what would that be? So if cash was $22 million in 2010, does that go up to like $26 million for 2011? Is that sort of the delta we need to be thinking about?

I'm looking at a schedule here. I would say that the cash -- it depends on where we end the year. The cash element, yes, it's probably $23 million, $24 million.

And then how should we think about what could happen at the end of the year in terms of, I guess awards. How do we think of that relative to where G&A would come, and then where guidance would come in terms of -- so that there is no negative surprises as we sit here, one year forward.

We are accruing at the same level from last year, and we are comfortable doing that at this point and that will be a quarterly accrual. To the extent that something were to change, and we bought a portfolio and had to hire a bunch of people, then we might increase that accrual. But given where we are right now, we are comfortable that the $28 million is a good number, and obviously as I said, the Company will make a determination at the end of the year.

Then maybe John, strategically, obviously, losing Dick but bringing Tyler up, and then hiring Chris and Eli, you certainly enhanced the senior management suite significantly with a lot of experience and clearly has been able to accrue benefits from the deal flow that you have been able to execute. I'm curious, as you think about the team that you assembled today, where could KRC be in terms of asset size, in terms of portfolio size and really monetizing the G&A load that you have today?

Well, that's a very good point, and it's one that we do focus on, and as we've said, Michael, everybody always wants to know what's our run rate on acquisitions and so forth. While we can't speak and we are unwilling to say that we will acquire a certain amount, I just want to call everybody's attention back to that time in Arizona when we had NAREIT, and I said, in this downturn, there is going to be opportunities to acquire, please don't forget that Kilroy did acquire when it made sense to acquire back in 1997 and 1998, and we didn't acquire in the bubble years, and we see in the years ahead the opportunity that is likely to be there. And now fast-forward to 2010 and again, we know what we did. We had no pipeline this time last year. We have a much better team in place, a bigger team, more analytical capability, more boots on the ground. Bigger geographic footprint. And I think that translates into a significant amount of acquisitions this year, all things being equal and you can imagine when all that is.

In addition, I think that development is going to come back into play faster than most people think, and I think that development won't be constrained to San Diego. Obviously we have expanded our footprint into other areas, with Eli, not only do we bring in somebody that knows the geographic area, and has looked at most of the buildings that were existing when Spieker was around, he either bought or looked at or knew not to buy. There's been a lot that were built since then. He brings with him a value-add skill-set that I think is going to be strong for Kilroy.

So big picture, I think the table is set, and if the opportunities are there, to be in the right markets and to grow substantially, then you should think of us as doing that, we certainly have positioned the balance sheet that way. And that is our hope, that we will see significant controlled disciplined growth, God-willing and macro conditions permitting.

That's helpful. And just this last question. Tyler, you outlined a range of 220 to 240, about a 10% spread. About $11 million in FFO. You were pretty narrow in the assumptions in terms of the elements of that. What sort of items would have a larger impact on that range, that we should be mindful of, getting from the low end to the high end of guidance?

Well, the lease-up of office occupancy is clearly a fundamental component of that, to the extent that we lease it more quickly and get the tenants in, in 2011 then that could provide some upside. We have embedded in our numbers $0.04 a share of legal costs associated with going after some tenants who were delinquent. If we don't end up spending that money, that's more upside, or potentially the other way, but it's really, the leasing that will drive the numbers at the end of the day.

You have the acquisition costs in there at all?

As I said, acquisitions, we don't include acquisitions or acquisition-related expenses. That can go both ways, right? So if we buy an accretive building, that could be positive. If we buy a building that's maybe value-added and has less accretion, but has some up-front-related costs, that could go the other way. It could go both ways.

Thank you.

Our next question comes from the line of Mitch Germain of JMP Securities.

John, you have mentioned the Valley as possibly an area of focus. Can I get your thoughts on that region?

Well, there is -- you are talking about Silicon Valley?

Yes.

And in that area, we have been in that market a number of different times. It's very important to stay in the right areas there. And I mean, if you think about it, there is Palo Alto, which nobody is going to be able to afford, at least not in these shoes, $900 or $1000 a square foot on Sand Hill Road. And then you kind of evolve from there, and go down to Mountain View and Cupertino and Sunnyvale. There are a lot of outliers, markets that we don't like.

We are looking at a variety of assets and been monitoring all of those areas I mentioned for the past year. And some things are going to be coming to market. There are a few things trading. So we are looking at that. And we are looking at where we can really create some substantial value on the things that are on our menu, if you will. We haven't pulled the trigger in that particular market yet. I do think in select cities, some of the ones I mentioned, if there is the right opportunity where we really think we can create value, then it would be logical to think of Kilroy being a player.

Thanks.

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

Hi. First question is a follow-up on the G&A guidance. I think last year, the Board switched from contemplating FFO to EBITDA in the plan and Tyler, it sounds like we are going back to FFO. Do you know if it was contemplated to keep EBITDA as a metric?

I don't think it was last year that we switched from FFO to EBITDA, it was a couple years ago, and the rationale for that is we didn't want financing decisions impact our incentives, and so we wanted to strip that out. So we've had EBITDA the last couple of years, I believe. And when you say we are going back to FFO, we are going back to everything. They will look at return, FFO per share, EBITDA, all the various metrics. There is nothing to be excluded here. FFO creates its own incentives. It incentivizes you not to do dispositions, because they're dilutive. It incentivizes you to do short term debt and it incentivizes you not to buy a vacant building. We don't want FFO per share as the primary source. But it's one category that we will look at.

Got it. Just the language in the proxy statement and your language earlier sounded like EBITDA was going to be excluded.

No, that's not it.

Thanks for that. Just a quick follow-up. In a separate item, AFFO, looking at the CapEx and the TI and LC line, this quarter was a little bit lower. Is that just timing and would you expect a higher run rate next year, based on some of the lease deals you have done this year and you expect to do -- or excuse me, that you did in 2010 and you expect to do in 2011?

Yes. 2010, the first two quarters we had very high TIs and Leasing commissions and in the third quarter dropped way down. And I think we gave some heads-up that we weren't going to maintain that low level that we had in the third quarter, and so the fourth quarter popped back up a little bit. Not quite to the level that we had earlier in the year, and our view for 2011 is that the numbers we had in the fourth quarter are probably a good range. It's going to go up and down, depending on the deal. The fourth-quarter number is probably a good proxy for 2011.

I'm sorry, in looking at page 17 or your AFFO section, I thought fourth quarter was kind of the lowest quarter for CapEx? Recurring CapEx?

Well, I'm thinking in a price per square foot basis. You are thinking on an absolute basis. You are right.

The difference being spend versus commence?

Right. Right. From a spending perspective, we see again, it depends on how much leasing we're doing. But CapEx of $45 million, $50 million for the year and that should moderate toward the end of the year. Assuming we have been leased up and we spent the money. To the extent we did more leasing, then that will continue.

Thank you.

Our next question comes from the line of Dave Rodgers from RBC Capital Markets.

Hey, John, I didn't hear if you provided it on the call, and you may have said it either directly or indirectly at investor day, but can you give us an update on where your LOIs are today, as well as your lease percentage through today?

Yes. Jeff, you want to do that?

Lease percent, we are 92% leased as a portfolio. LOI is 400,000 square feet outstanding. I'll let Jeff comment further.

On the LOIs, 400,000 square feet, two-thirds is in the Office, and one-third is in Industrial and it's split about evenly between new space versus renewal. And I think the leaders would be, San Diego is 41%. LA is 31%, Orange County is 23%, and San Francisco is 4%.

And spreads I assume are consistent with that 10% number that you gave down on a cash basis, can you tell us, or give us some indication of how Office and Industrial separately are performing in terms of a contribution to that?

In terms of the change in rents?

Are you looking at a weighted number? Is that what you're asking, Dave?

Yes. I mean, the 10% I guess is your weighted number, and we saw what happened in the fourth quarter of the down 10 and down 35, and consistent with those numbers or are we making progress relative to that?

The 10% is an overall portfolio for all of our lease expirations going forward of where we think our rents are versus market. That's a little different than what we have been signing. Obviously, there's a different subset there.

The good news about Industrial, the bad news is that it was way off in rent. The good news is that it's 97% leased. It's sort of put away for awhile and as Tyler said, we are 10% and we view our portfolio is 10% above market. Obviously that can change depending on what's happened in the market. Are we giving the answer you need? You have kind of a couple parts to your question.

Let me ask you a little bit differently. So if 10% is the mark-to-market for the whole portfolio and not necessarily just 2011. Do you have a number for 2011 that you can baked in for a spread in aggregate for 2011?

Yes. It's about -- those expirations are probably 15% above market. The one out in Camarillo that Jeff mentioned, is a little bit higher than the average.

And that's what weights it up.

Right.

Weights the percentage up.

Okay. And I guess on acquisitions, what are you finding in terms of pricing on those acquisitions? Are those prices continuing to move up, and are you feeling comfortable depending how you want to answer this question, with even moving your own growth estimates up to meet some of that pricing given what you are seeing and the discussions you are having?

To the first part our Cap rates have sort of been in the, I guess on average sort of the high sixes. Some cases a little bit better. On in-place income, some of those buildings obviously were not fully leased. As an example, the Liberty Station building that we bought was 95% leased. That was 7.8%. The building we just bought at 250 Brannan was 77% leased with a 6.8% going-in cap rates, we moved that into the eights with the leasing that we will do and the vacant piece.

To the bigger issue, where are Cap rates going, and so forth. We have seen some deals, and are hearing about some deals that are supposedly in escrow that are assets that we wouldn't touch, where the Cap rates are higher, and there are some cases it's Cap rates in this range, but for well over Market rents, that we think is a fool's game, unless there is something that is going to drive those rents way back up, very shortly. So it's always a building-by-building analysis. But what we we're looking at, and the building we just bought on Brannan is a good example. We bought a great building. It's a small acquisition. It's only $33 million. But we feel we can move up the yield substantially.

We feel the rents that we underwrote it to have already -- the Market rents have increased above that. There is a little gold mine in that building in the parking we think we are going to be able to move up. In the bigger context, we have a number of properties that we are in negotiations right now on and the yields are very similar to the ones that we achieved in the acquisitions, and they are stabilized and in some cases, we have a value-added building that we hope to be successful on, where the yield's going to be, the going-in yield's going to be somewhere in the neighborhood of 5%, but there's a lot of leasing to do. It has been a landlord that had no capital, and didn't have a team, great building, just totally messed up, we look at that as an opportunity to move the leasing up. We think the rents in the neighborhood are going to go up by 25% to 35% over the next year, based upon what's happening right now.

So we are going to see assets that range from the kinds of things we have been buying, to value-added opportunities. It's a big market. There is a lot of stuff that is for sale. A lot more that's coming for sale; there are a lot of people that are out there buying. Some of them I don't think are buying at numbers that make sense to us. But like I say, there are a lot of transactions, and if we can't get the number we want, we push away. I'm convinced that we are going to see a fair level of successful acquisitions this year based upon what we are actively pursuing right now, and our pipeline is very, very significant.

Thank you for that and last question for Tyler, projection for capitalized G&A or capitalized interest in 2011, if you have one.

Cap interest is about $2.5 million a quarter and that's related primarily to One Paseo. A little bit at El Segundo.

Okay.

Thank you.

Our next question comes from the line of George Alba from ISI Group.

Great, thanks. Tyler just a question on Reimbursement margins, and Operating Expense margins. Where do you see those shaking out in 2011 versus 2010?

In terms of the recovery percentages, we used to be higher, in the high 30s. A combination of lower occupancy and our acquisitions drove us into the high 20s. We think that will move up into the 30s, low 30s this year.

And on the Expense margins?

I think we have been running in the low 70% range again. Some of the buildings we purchased are full service gross. San Francisco building, which have a lower margin. It's probably around the 70% level.

Can you remind us of the cash yields on the 4Q acquisitions?

Sure. On 250 Brannan, I think John just said that -- that's actually a 2011, but that's a 6.8 cap but it's on 77% leased. On Liberty Station, it was 7.8%. On Overlake, it was 6.4%. And on 100 First, that's where it's 76% occupied and it's a 5 cap going in, but it's leased to 95%, so when the tenant moves in, it jumps to a 7%.

Okay. Thank you.

Sure.

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

Great, thank you. John, you talked a lot about your development potential. Tell us how we should think about the land situation. You've got about $267 million of total basis in the land, based on estimated rentable square feet, that comes out to a very, very high dollar -- $113 per buildable foot and it comes out to roughly $2.3 million per acre. So the two questions are, basis versus value, and then the second question is, what kind of build on development can you get, given these land bases?

I don't know that I have those numbers right here.

It's on page 26 of the supplemental.

I think what John is saying is, in terms of the value of the land per property, I'm not sure that we have a good current estimate in front of us, of what the value for each building is, or each piece of land is.

I think from a yield perspective, the numbers we continue to model on our pro formas, when we talk to the tenants that John mentioned, we are still in the 8% to 9% return on cost yields, including the land price that we have. Obviously the biggest component of that value is the One Paseo project, which I think is, of the numbers you mentioned, probably half the cost. If you strip that out, it changes the analysis for the other properties, and that's the one where we are improving entitlement. So obviously, to the extent we can improve entitlement, it changes the game on that project.

The vast majority of your land basis is One Paseo, which is $4.7 million per acre and Santa Fe Summit, which is $3.7 million per acre. Okay, great. Thank you very much.

Sure.

And the next question comes from the line of Tom Truxillio from Banc of America-Merrill Lynch.

Hi, thanks. Question from a fixed income perspective. Obviously, your leverage has ticked up since you guys issued back in May in an unsecured market. At the time, you said, future acquisitions would be financed in a leverage-neutral manner. So given that, is it safe to say or safe to assume that financing of these future acquisition opportunities that you talk about, will be more skewed towards equity, in order to get that leverage back in line, where it was a few quarters ago? Or do you see operating the balance sheet levered like it is now?

I think what we said we were sort of under-levered in the high 30s and we moved into the low 40s. I think what we said, is if it ticks up into the mid-40s, we are clearly going to be thinking about different ways to raise capital, either through equity or potentially through disposition. So I'm not sure we were viewing ourselves right now as too highly-levered. At this point, if we did another several hundred million dollars of acquisitions we would need to think again about whether it's to do some dispositions to raise equity, or to raise equity in the market. Our debt to EBITDA in a pro forma basis is in 6.6 range. Our coverage ratio based on bank definition is 2.5 times. I think we have pretty good statistics, but we certainly have an eye on our leverage. We are going to maintain a conservative balance sheet, so that we can access opportunities when they come along.

Great. Thank you for the comments. I appreciate it.

Sure.

And our next question comes from the line of Michael Knott of Green Street Advisors.

Guys, just in the sort of the in the vein of sort of optimistic comments about development. Can you talk about your expectations for the redevelopment, and leasing time lines there? What tenants might be interested, and just kind of how you think that process is going so far?

Is he referring to El Segundo?

Yes.

We don't really want to get into too much about where we are on a lease negotiation, but just say that we are in a negotiation with regard to that building. And beyond that, we have a number of tenants that are interested in a couple of floors that building. We were in a situation where sometime, and I don't want to get into time lines on this call because you never know who is listening to these calls beside the analysts and the investors, but let's say that we are -- our activity on that particularly project is very good.

Okay. So you feel good about that as you do about the development parcels you talked about?

Well, I always feel good until for some reason we don't feel good, and right now we feel pretty good with regard to where that building is in the marketplace, and how it's being repositioned and so forth. And really can't say a whole lot more than that, Michael.

No problem. And then lastly, does Eli's hiring signal sort of your greater intention to get into Silicon Valley? I think you touched on that earlier. Is that part of the consideration for bringing him onboard?

Well, I will tell you how that all came about. We didn't go out looking for a new Chief Investment officer. We had hired Chris back when we didn't know when we were going to be acquiring, what we were going to be acquiring, and we wanted to look at things in a more strategic sense, markets as well as investment opportunities and so forth. And then, we began to acquire in the, what was the second quarter of last year, and Chris very admirably and capably guided us in that acquisition phase, and when we began, as we always said, when we had enough critical mass in San Francisco, what we decided is that we would have San Francisco sort of be the Northern California, Northwest office location for Kilroy, and we would populate that only with the people we acquired through the acquisition, but with the Vice President of Asset Management, and a person that would be able to help the Company with regard to that which we had acquired and that which we might acquire, and development and so forth that knew the Bay area very well.

And in the course of interviewing candidates for that particular post, and Eli was one of them, it was very clear that he had skill sets way beyond that, and had skill sets that would lend itself to the acquisition activity, and had the knowledge in his two roles over the last 20 years with Speaker and Broadreach to be very familiar with culture of a Public company. Speaker and Kilroy had a lot of similarities with regard to the character of people and whatnot. Obviously, Speaker had a footprint that is now very much like the footprint Kilroy has, though they had more assets. So it's natural to think of him in a larger capacity, and that allowed them or Chris to move him back where we wanted him to be with to begin with.

It was not a signal per se that Silicon Valley was now an area that we were going to play in. There is no hidden message there. But the fact that he has seen buildings in that and other markets, including the greater Northwest, the assets that have served the test of time, as we know in our business, it is not just about the market. It's about the individual assets, it's the bones of the assets, if it's value-added you have to understand development, he cut his teeth on that, he ended up being the sort of the perfect candidate for that position. Again, we were looking at a number of things in Silicon Valley, we did not bring Eli in because, all of a sudden we have a big design on that particular area. It was much broader and more thoughtful than that.

Got it. Thank you.

You're welcome.

We have a question from the line of Steve Boyd from Cowen and Company.

Hi, thanks. I might have missed this, but what is the same-store NOI growth assumption that's underpinning your 2011 guidance?

You didn't miss that. It hasn't come up. We project right now about a 5% same store growth, both on a cash and GAAP basis roughly.

So it should be pretty similar on the basis?

Yes.

The $0.04 of legal expenses you mentioned earlier, would that be in the mid-point of guidance? How should we think about that?

Yes.

Yes? Okay, great. Thank you.

Sure.

And we have no further questions.

Great, well thank you for joining us today. We appreciate your interest in KRC.

Ladies and gentlemen, thank you for your participation in today's conference, this concludes the presentation. You may now disconnect and have a great day.