Kilroy Realty Corp (KRC) 2011 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first quarter 2011 Kilroy Realty Group Inc. earnings conference call.

(Operator Instructions).

As a reminder, this conference is being recorded for replay purposes. I will now turn the presentation over to your host for today, to Tyler Rose, Executive Vice President and Chief Financial Officer. You may proceed.

Good morning, everyone. Thank you for joining us. With me today are John Kilroy, our CEO, Jeff Hawken, our COO, Eli Khouri, our CIO, Heidi Roth, our Controller, and Michelle Ngo, our Treasurer.

At the outset, I need to say that some of the information we will be discussing this morning is forward-looking in nature. Please refer to our supplemental package for a statement regarding the forward-looking information in this call, and in the supplemental. This call is being telecast live on our website, and will be available for replay for the next seven 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 a look at our key markets. I'll follow John with financial highlights, and updated earnings guidance for 2011. Then we'll be happy to take your questions. John?

Thanks, Tyler. Hello, everyone, and thank you for joining us today. We made good progress at KRC since the beginning of the year, building on the strong momentum we created in 2010. Our leasing program continues to generate good results. Our stabilized portfolio metrics are improving. We continue to find high-quality acquisition opportunities that will create increased shareholder value over time. We continue to expand the KRC footprint, and we've maintained a solid balance sheet that positions us well to continue to grow, going forward.

We have done this against the backdrop of a West Coast economy that continues to stabilize, with pockets of strength emerging in many of the sub-markets in which we are active. We had a strong leasing quarter, signing new or renewing leases on approximately 350,000 square-feet of space. We also have in-place LOIs, of almost 300,000 square feet. Occupancy in our stabilized portfolio was 90.8% at the end of the first quarter, up from 89.1% at the end of the fourth quarter, and 82.8% a year ago, an 800 basis point year-over-year improvement.

Higher occupancy is improving the financial performance of the portfolio, with first-quarter same-store NOI up 4.4% on a GAAP basis, and 1.4% on a cash basis. On the acquisition front, we are pursuing opportunities that fit our strategic framework. We continue to evaluate core properties that offer upside, and are now focusing as well on value-added opportunities, including properties with sound fundamentals in our target sub-markets, but that have a lease-up or redevelopment component that will allow us to increase value over time. Since the beginning of the year, we closed two transactions, are in escrow on three more, and are in final negotiations on another three properties. And we are continuing to evaluate a strong pipeline of additional opportunities.

Let me provide some details on these acquisitions, although we are limited in what we can disclose, since we are still under confidentiality agreements on many of them. As we previously reported, in January we completed our third acquisition in the South Financial District of San Francisco, 250 Brannan Street. The property is a good example of a value-added proposition. We bought the three-story, 91,000 square-foot building for $33 million. It's currently 77% occupied, with in-place cap rate of 6.8%. The building is located in a highly desirable area that appeals to technology and media tenants. And we have already signed an LOI, to lease the remainder of the building at a rent and concession package that is better than budget. The projected stabilized cap rate is now 8.3%.

Last month, we completed our second acquisition of the year, the Plaza at Yarrow Bay. This is a four building, 280,000 square-foot office complex located on the east side of Seattle near Lake Washington. We paid just over $100 million for the project or about $358 per square foot, which we estimate is approximately 20% below replacement cost. The cap rate on the project is approximately 6.1% based on current occupancy of 87%. The complex has historically has commanded rent premiums compared to similar projects, given its high-quality tenant profile that includes Watermark, Bill Gate's personal company, Electronic Evidence, a legal evidence analytics company, and Elias, a technology consulting and staffing firm.

In terms of our pipeline, we are in escrow on two acquisitions in the Bay area that total $135 million, and an acquisition in San Diego that totals $33 million. In addition, we are in final negotiations on three other acquisitions, one in the Bay Area, two in Southern California, totaling approximately $160 million. Two of these properties, come with existing debt, totaling $83 million. We expect to close these six transactions sometime in the second or third quarter, subject to customary closing conditions.

To recap, we've closed $133 million of acquisitions year-to-date, are in escrow on $168 million, and are in final negotiations for an additional $162 million, which in aggregate, assuming they all close, would total approximately $463 million. Tyler will discuss our funding activity for these acquisitions in his remarks, but we intend to remain financially disciplined with conservative leverage, and have the ability to take advantage of additional growth opportunities as they arise.

As we have discussed before, some of those growth opportunities may come in the form of new development, potentially as soon as this year. While negotiations continue to take time, we're having ongoing discussions with a variety of tenants who have expressed interest in opportunities to pre-lease new development. These include tenants in the tech, healthcare, and financial services sectors.

Now, let's take a closer look at our individual markets. Starting in San Diego, the region experienced positive absorption for the sixth consecutive quarter. Job growth has resumed, with the region adding jobs in February and March led by the professional services sector. Pricing power remains modest in San Diego, but with increased activity particularly in Sorrento Mesa, and Mission Valley, there is the expectations that rents should begin to increase. Our portfolio in San Diego is now 90% leased.

Moving north to Orange County, the office market continues to recover, experiencing positive net absorption for the third consecutive quarter. First quarter leasing activity was strong, with absorption totaling 380,000 square-feet. To put that into perspective, it's about the same as the absorption for all of 2010, which totaled approximately 450,000 square-feet. Increased demand was generally in the greater airport area sub-market, and was led by the leisure and hospitality sectors.

Job growth has also resumed in Orange County, with positive numbers in both February and March. As with San Diego, rents have yet to show much improvement. The Orange County industrial market continues to improve with a fourth consecutive quarter of positive absorption, with 790,000 square feet. This market -- this marks the largest positive number since the fourth quarter of 2006. Our Orange County office portfolio is approximately 95% leased, and our industrial properties are nearly 100% leased.

Continuing north, the greater LA metro area has been slower to gain sustained traction in job growth, although the trend has turned generally positive, as the office market had positive absorption for the first time in several years. Overall, vacancy rates also declined in the first quarter. In West Los Angeles, market demand and tenant activity has begun to pick up, with rising interest from a range of entertainment, media and gaming firms. Our Los Angeles portfolio is now 92% leased.

Now, let's move on to northern California. San Francisco experienced a third consecutive quarter of positive absorption, and job growth turned positive across the metro area in the first quarter. Visible signs of a healthy recovery in the area can be seen in the amount of available and vacant office space, which is the lowest since late 2008. The strong and steady leasing activity in our South Financial District sub-market continues to be primarily driven by technology and media tenants. Our San Francisco portfolio represented 12% of our year-to-date NOI. Overall, our San Francisco properties are currently 95% leased.

Finally, the greater metro areas are now exhibiting positive job growth, and our Eastside sub-markets continue to experience positive absorption. With the recent completion of our second acquisition in Seattle's Eastside sub-market, we've expanded our platform to over 400,000 square feet. Our properties there are 93% leased.

As a result of our success in the Bay area and Seattle, we have created a new regional headquarters in San Francisco, and are currently building out a regional office at our 101st Plaza property. Mike Sanford, our new Vice President for that region, and Eli Khouri, our Chief Investment Officer, will be based in that office. Over time, as we grow our presence in the Puget Sound area, we may add another regional office there as well.

That's an update on our market conditions and activity. As we move through 2011, we remain focused on operating excellence and growth opportunities. To summarize our goals, we will aggressively market our core portfolio to move occupancy back to historical levels, and increase rents as economic conditions allow. We will continue to pursue acquisition opportunities in the best West Coast markets. We will maintain our commitment to a strong balance sheet and strong credit profile. And we will continue to explore development options as demand strengthens, and as these opportunities makes sense. Finally, we are very pleased with the additions we have made to the management team over the last year, and believe we are well-positioned to accomplish the goals just outlined. Now, I will turn the call over to Tyler, who will cover our financial results in more detail. Tyler?

Thanks, John. Hello, everyone. Thanks for joining us. FFO was $0.55 per share in the first quarter, included about a net $0.03 a share in legal and acquisition-related costs, so our core FFO was about $0.58 a share.

Included in those costs were $0.03 a share of litigation expenses for a dispute with a tenant, who defaulted on one of our Orange County buildings in 2009. The jury ruled in our favor, with a damage award of approximately $2 million. And as part of the process, we will be seeking the reimbursement of our legal fees. However, the timing and final outcome of legal matters is difficult to determine, so we haven't included any payment that under the court award in our 2011 guidance.

Additionally, we incurred approximately $0.01 per share in acquisition-related expenses. As we've previously discussed, given their uncertainty, we don't budget these types of costs. Finally, we received a $0.01 a share benefit, related to the collection of a credit support funds -- on a separate tenant default issue.

As John mentioned, we ended the first quarter with occupancy in our stabilized portfolio at 90.8%. By product type, industrial occupancy rose to 95.9% at the end of the first quarter, from 93.9% at the end of 2010. Office occupancy increased to 89%, from 87.5% at year-end. Overall, our properties are now 93% leased.

Same-store NOI continued to improve in the first quarter, increasing 4.4% on a GAAP basis, and 1.4% on a cash basis. The improvement reflects our higher average occupancy, which increased by 820 basis points, from 82.4% a year ago, to 90.6% in the first quarter. For leases we signed during the first quarter, rents on office leases were down 9.4% on a GAAP basis, and 14.8% on a cash basis. For industrial leases, GAAP rents were down 29.6%, and cash rents were down 34%. Our industrial portfolio's NOI now accounts for about 7% of the Company's total NOI.

By region, rents on leases we signed in Los Angeles during the first quarter were up 1.8% on a GAAP basis, and down 5.2% on a cash basis. In Orange County, rents were down 29.6% on a GAAP basis, and 34% on a cash basis. And in San Diego, rents were down 33.6% on a GAAP basis, and 35.1% on a cash basis. As John mentioned, we currently have approximately 300,000 square-feet of LOIs, almost all are office, and 70% are new leases. For these leases, rents were up 1.1% on a GAAP basis, and down 4.4% on a cash basis.

We estimate that rent levels in our overall portfolio remain about 10% over market. Our lease expirations for the remainder of 2011 total about 590,000 square-feet, or roughly 4.7% of total expiring leases in our lease portfolio. The largest expiration is a 205,000 square-foot office lease in Ventura County that expired at the end of April. The tenant had originally indicated that it would renew half the building upon its lease expiration at the end of April. But its plans changed, and it has now moved out of the entire building. We now assume it will be vacant through 2011.

In terms of our acquisitions, we closed two year-to-date, totaling approximately $133 million. The average in-place cap rate is approximately 6.3%, with an average occupancy of approximately 85%. On a stabilized basis, the cap rate is projected to be approximately 7.1%. In early April, in light of our growing acquisitions pipeline and strategy to maintain a strong and conservative balance sheet, we made a decision to raise equity, selling just over 6 million shares at a price of $38.25 per share for net proceeds of approximately $221.2 million. This capital will allow us to fund our recent and pending acquisitions, so that our overall leverage remains approximately the same, and positions us to continue to take advantage of additional growth opportunities.

Now let's discuss updated guidance for 2011. To begin, let me remind you that with all the uncertainties in today's economy, we continue to approach our near-term performance forecasting with a lot of caution. Our internal forecasting and guidance reflects information and market intelligence, as we know it today. Any significant shifts in the economy or our markets going forward could have a meaningful impact on our results in ways not currently reflected in our analysis.

With those caveats, our assumptions are as follows, we continue to project that our average 2011 occupancy will be 91%, with a year-end occupancy of 93%. This includes lower projected occupancy in the Ventura County property given the move-out I just mentioned, and that our acquisition properties will be on average about 88% occupied at closing. We are not assuming any additional material legal costs for the collection of the court-ordered amount in our recent litigation.

Our 4.25% exchangeable notes to 2014 are now in the money from a GAAP perspective, since the original strike price was $35.93. Under GAAP, we are required to add the shares into our weighted average calculation to calculate earnings. There was no material impact in the first quarter, but assuming an average stock price of $41.00 per share for the rest of year, the additional impact -- the impact of the additional shares will be approximately $0.02 a share dilutive for the full-year. It is also important to note that we purchased a cap call in this transaction, so there was no true dilution at this point, since the economic strike price is really $42.81.

In terms of acquisitions, as we have previously discussed, our initial 2011 FFO guidance didn't include any acquisitions or acquisition-related expenses. Our guidance will now include the two completed acquisitions, 250 Brannan and the Plaza at Yarrow Bay, the three acquisitions under contract, and the three acquisitions in final negotiation. In addition, we take into consideration our recent equity offering that effectively funded these acquisitions on a leverage-neutral basis.

Combining the partial year impact from the acquisitions with the equity offering results in roughly $0.03 a share of accretion over the remainder of year -- of remainder of the year, subject to the timing of the closings, which we anticipate will be early to mid third quarter on average. We also project that in 2011 we will have acquisition-related expenses for these eight transactions that we estimate may total approximately $0.05 per share.

Finally, there are no dispositions, development starts or additional acquisitions in our guidance. So while we have some net dilution, primarily from the acquisition-related expenses and the first quarter litigation costs, our improving operating performance effectively offsets that. And we can provide updated 2011 FFO guidance that tightens our previous range of $2.20 to $2.40 per share to a new range of $2.22 to $2.36 per share. That's the latest news from KRC. Now we will be happy to take your questions.

Thank you.

(Operator Instructions).

And the first question is from the line of Jamie Feldman from Bank of America. You may proceed.

Thank you, and good afternoon. Tyler, can you talk about what -- so the revised guidance range, what does that mean in terms of same-store NOI, on a cash basis, without term fees?

Yes, when we gave guidance on the last quarter, it was about 5%, and that hasn't changed much. So it's roughly the same, 5%.

Okay. And then, do you have an update on your FAD, in dividend coverage?

Yes, I mean, you probably saw that we covered slightly in the first quarter. That was more of a timing difference, related to the timing of lease -- tenant improvements and leasing commission costs. So, as I think we said again, last quarter, we anticipate that we'll cover on a more run rate basis, starting in the fourth quarter of this year and going into next year.

So, it sounds like you will be kind of -- at your dividend level, on FAD this year?

Yes, overall for the year, yes, roughly.

Okay. And then finally, I know you had made some commentary about above and below market, so the leasing spreads in the quarter were obviously a pretty sharp decline. What is your expectation for the next three quarters?

Well, for the remainder of 2010, we were about the same, 10% over market for the expirations that we have on the 590,000 square-feet.

Okay. So average -- minus 10% cash leasing spreads?

Yes. And that assumes the move-out of the -- that doesn't include the Ventura County property that the tenant has already moved out on.

Are you having discussions on that space yet?

Yes, we're obviously in the market, have been in the market, looking for prospective tenants. We have some interest -- and it's a little bit early to tell how quickly that's going to re-lease up, but certainly, are looking across the board.

Okay. All right. Thank you.

Your next question comes from the line of Sri Nagarajan from FBR Capital Markets. You may proceed.

Thanks, good morning. In terms of the 330,000 square-feet in LOI can you just give us some color on the submarkets, specifically interested vis-a-vis your comments on both Sorrento Mesa and Mission Valley? And -- it seems like you have picked up there, a lot?

This is Jeff, in terms of the LOI's, that was your question, the 300,000?

Right.

Yes. The majority of that, 65% of the 300,000 is in LA, 6% is in Orange County, 22% is in San Diego, and 8% is in San Francisco. So, it 's heavily weighted to LA, for that subset.

Okay. And so would it be then that you are seeing a lot more activity in West LA, that has kind of remained stagnant in the first quarter, as well as the later part of the last year?

Yes, I think that is fair to say, that we are seeing more activity in LA, including West LA. So we're starting to see more interest and more traction.

Fair enough. And, in terms of the build-to-suit activity/development that John's comments, could you expand a little bit on that? Obviously, with respect to the markets, as well as the kind of tenants that are looking for development projects here?

Yes, hello, Hi, Sri, this is John. Excuse me, I got a little bit of a frog in my throat. The development things we are looking at right now is, we are in negotiation on a fairly substantial facility that -- it's a combination R&D, office and some manufacturing, several hundred thousand square feet, to the smaller end, which is the 60,000, 80,000 square foot corporate headquarters. So they sort of range from big to small.

And obviously, what's driving that is folks are finding it difficult in some markets to locate space that is of the quality, or has the particular amenities, power, whatever it might be, that they need within the existing stock, because the existing stock, obviously, has been leasing up. And a lot of what is out there, in the vacancy rates are literally dozens and dozens of 10,000 and 15,000 square-foot spaces that, when in aggregate, they account for a lot of square footage, but they don't accommodate the larger users' needs.

And just to be clear, on the guidance front, Tyler, your guidance includes the transaction costs or acquisition costs, as well as the dilution due to the exchangeable notes?

Yes.

Okay. And, finally in the lease term fees disclosure, obviously, it was -- I want to know if there was any significant lease term fees in the quarter? And going forward, would you be disclosing it back again?

Yes, the lease term fees in the first quarter were about 280,000 square-feet. And we will be disclosing that the future.

All right. Thank you.

And your next question comes from the line of Michael Bilerman representing Citi. You may proceed.

Hi, this is Mark Mahaney in here, with Michael and Josh. First question, just on the acquisitions, wondering if you could discuss some of the economics on them? And as well, I know you mentioned that you're looking for acquisitions with either lease up or development opportunities. It sounds like at an 88% average lease rate, there's not a whole lot of room for lease up. Do these projects include some development component to them as well?

Yes, this is John. I am going to take the first part of that, and then with regard to where some of the upside is, beyond what is obvious, I'm going to turn it over to Eli. On the two assets that we have acquired year-to-date, plus the three assets under contract, plus the three assets that we're in the final stages of negotiation, the total purchase price is $330 million. Is that correct?

That doesn't include the close, that's just the --

Excuse me, I beg your pardon, that would be -- I thought that was wrong. The total -- let's call it the total -- let's go back to year-to-date. On the two assets year-to-date, $133.1 million, 100,000; $359 a foot, 371,000 square feet, estimated discount to replacement costs of about 21%, debt assumption of roughly $30 million, occupancy at closing 85%, percentage leased at closing 92%, in-place ROC at 6.3%, estimated stabilized ROC of just around 71%, 72%, and an estimated unleveraged IRR of just at roughly 10%. On the six pending transactions, the total is $330 million and change, $277 a square-foot average, 1.2 million square-feet, an estimated discount to replacement costs of roughly 38%, debt assumption of roughly $83 million, leases that closed 88%, cap rate in-place ROC at 5.4%. But cap rate on stabilization estimated in the sixes, 6.8%, 6.9%, and unleveraged IRR forecasted at 10.2%.

Now I must say that on some of these acquisitions, there is value -- there is -- we've calculated any future development as part of the purchase price attributable to the square footage, and not given any value to it. There is some development upside, for what we're getting into that. And then, with regard to the upside beyond the obvious, the lease up and/or some future development, Eli, you can talk about where these things -- where the rents are versus where they have kind of been in the high water, and where we think they're going in the marketplace.

Sure. I think we are getting a value, in two additional places, when we are doing these more value-add or core-plus types of acquisitions. The first place is the way that we actually buy them. If you look at the things that we have in contract right now, we have two off market. We have one coming from a broken marketing process where they lost the buyer, and it came back at a substantially lower price.

One that was very lightly marketed, and one that was marketed, but we didn't have to pay the high price because we were good buyers. So, we tried to get at least some part of the value, in just buying good value up front. But with respect to additional upside, we are talking about a lot of projects that have been significantly under-capitalized and significantly under-managed. And so there was upside in doing both of those right. But even if you look, and these are so -- if you look at the ones that we are talking about, we have some lease up, but they all have rollover. So going from 88 to call it the low 90s is part of the upside.

If you look at the in-place rents, relative to even current market rents, you have a low teens kind of growth rate there. And if you look at the in-place rents, relative to peak market rents -- and I would use peak market rents from the 2007, 2008 kind of peak, not the internet bubble, because this number would be higher, if we were doing that. But you are looking at growth rates to mark, to previous peak market rents, in excess of 20%. And to achieve all of those things, we are going to have to handle the properties right. We're going to have to put some capital in. We're going to have to manage them properly and aggressively. But I think these have -- the attractive aspect that all of these have is substantial value creation and income growth potential.

John, this is Michael Bilerman speaking. Just a question on, as we think about the pipeline, as well as future capital raises, back when you did the equity offering, you raised $230 million gross. You talked about a pipeline in the billions I think was the way you characterized what it was, relative to the year prior, where you were starting basically at zero, and ended up acquiring -- had done 700 total at that point.

I guess, with talking about now having 330, these six assets, which obviously, you have added two more assets since you've done the equity raise, is bringing some of that pipeline in. But you're also talking about some potential development going forward, and wanting to keep a balance sheet that's reasonably low levered. I guess, how should we think about your pending capital raises to handle this future growth, both from the standpoint of additional common equity as you think about converts? And just how should we think about potential -- what is going to be on the come, given that you effectively spent the money that you wanted, that you raised?

Well, those are good questions, and obviously, we are going to continue to be flexible. But as far -- one thing we really haven't spent a lot of time talking about, as we've constantly said, that think of us just as we did, when we were developing at a pretty fast clip in the development years, we would recycle capital there through dispositions. And while we don't forecast dispositions, for obvious reasons, what you should think of Kilroy as doing some dispositions this year. So that's one side of it. And then Tyler, with regard to the mixture of whether there is equity or converts or whatever, you want to hit that one?

Yes. I mean, we have right now, fairly low leverage, so we have room to grow, obviously on the debt side through straightforward bonds, whether it is five, seven, ten year bonds. Will we would do another convertible? Maybe, but probably lean against that. There is certainly the preferred market, and then there is the equity market. And we are going to manage our balance sheet to stay conservative to give us capacity to continue to grow. But we have a fair amount of room right now, not to have to raise equity now for a while. And it obviously depends on how quickly we grow and what the opportunities are. But --

Well, I guess that's what I'm trying to figure out. I mean, you raised money in April. You talked about a pipeline of -- you have the two assets you were going to close, and you had 170 in the pipe. Now the pipe is 330 that you're going close. I guess how much -- where are you willing to take leverage before you raise more equity? I'm just trying to balance that out. You do want to keep a balance sheet that is low leveraged to continue opportunities, but you also say that you could raise leverage. So, I'm just trying to figure out which one it is.

Well, our debt-to-market cap now is in the mid 30s. Right? I mean we, as we said before, we are comfortable going into the mid-40s, on a leverage basis for a period of time before we would need to raise equity. If we got into the high 40s, I think we would probably either be selling assets, or raising equity, or doing something else.

Did you look at it debt-to-EBITDA or you just -- debt-to-market cap?

Debt to EBITDA, as well. We are in the mid sixes right now, in debt-to-EBITDA. Once we go into the low to mid sevens, again, from a ratings perspective, we need to watch that. And, so we do look at debt-to-EBITDA.

Okay, great. Thank you.

And your next question comes from the line of Chris Caton from Morgan Stanley. You may proceed.

Hi, good morning. I'm hoping you could revisit the -- first the redevelopment project, the old Boeing space, I think it's out on Imperial Highway? How is that going, I think it is slated for third quarter completion? I wonder if you're marketing that space?

Yes, the work -- this is Jeff. The work at that project is basically underway, and commencing construction, and we anticipate it will be complete by the end of the year.

And are you marketing it for lease at all?

Yes, we are. We're talking with a number of folks about the opportunities in that 2260 building.

But I suppose, what budget do you think -- and do you think you can beat it, given the traffic that you're seeing now? Or do you think it could take until -- just an estimated stabilization date in the supp of a year-and-a-half from now?

I think based on the activity we are seeing, we're optimistic that we could outperform that . It's going to take a little time to process through, the deals we are talking with, we've got some large deals, and some smaller deals. But, our expectations here today would be that we could probably beat that

That's helpful. And then John, just on acquisitions, you talked about pursuing more value-added situations. Maybe could you give us a sense of the pricing you're seeing for very stabilized, call it core or ultra core type projects? And then, where you see stabilized yields for kind of the value-added deals you're looking at, and what is that spread? Why do you like it? Why do you like taking the risk at this point, that sort of thing?

Well, again, I'm going to ask Eli to opine on some of this as well. First of all, we love core. And the stuff we bought, 303 and 101st and assets like that last year, we did very well on those, buying them at the timing that we did. And if those were to trade today, they'd trade at a far higher price, far lower cap rate. Having said that, there are a couple of -- some metrics that we really look at. Obviously, at this point in the cycle, we like big discounts to replacement cost. We like credit profiles, we like where we can move the, create additional value.

You can create additional value even on some of these core assets, because to the extent that you are able to buy it at a big discount, and you get your hands on some rental increases over time you -- the math works pretty nicely. Although, looking at your big question, which is the differential, really on cap rate basis, because price per square foot, some of the core stuff, frankly, could be bought at attractive costs per square foot. But it's because the leasing was done at a time when they gave a lot of free rent and very low rent, in-place rents. And so, that's reflective of the price per square foot. Now, on a yield basis, we're sort of saying the core stuff, in the high fives to early sixes for stabilized assets, sometimes it's a little bit higher, depending on what the growth pattern is.

And then, with regard to the value-added, it's all over the lot, because it really depends whether you buy a vacant asset, or whether you buy an asset that might be fully leased, but has fairly -- if you roll fairly soon. Obviously, it depends upon whether or not it's been capital-starved. And of course, it depends -- I'm only -- my comments are only relative to markets that we want to go in. There is all kinds of comments that one could make to secondary or tertiary markets. Eli, as I think everybody knows, Eli before --speaker for a long time, but for the last ten years or so, in private equity side, looking at value-add things. So his experience there is over a longer period than mine. So do you have any further comments?

Yes. I mean, I think it's a good question, and the question on the spread. And what has happened, particularly over the last six months, as you've seen, two sets of assets move up really sharply in price, with a lot of the other assets not moving up with them. So you do have a pretty good spread. Now what -- how you identify that spread, I'll talk about that in a second. But the two categories that have run up a lot are the long-term, quality net lease deals. And the second one are the class A buildings in gateway markets that are fully leased, but that they are multi-tenant, and do have rollover. And so, those have run up sharply.

The more value-add, you can even be in core plus, have not run up near as sharply. Now in terms of actually buying those assets, it can be all over the board. I mean, I would say the criteria that we are focused on most is number one, is buying an asset -- put price aside for a moment -- but buying an asset that needs a lot of help. But once we've gone through everything that we need to on the asset, it's in a location, and it's of a physical quality that we think is appropriate for the portfolio, that is going to provide long-term attractiveness, and be -- and reach a very high value. So, that is the first criteria.

And, we look at the discount to replacement cost. We look at the discount of the rents. We look at the activity of the previous ownership, and whether they were skilled at what they did, or what they didn't do, and those kinds of things. But probably, to try to quantify it a little bit, perhaps there is a 200 basis point spread in IRRs, between those two categories I mentioned, long-term net lease, and the class A buildings, between that class, and between the typical value-add class on IRRs. So, maybe -- and that can vary quite a bit. The best value-add deals might do a little better than that, and the worst might do a little bit worse than that. So.

Is that getting at your question?

No, that does exactly answer my question. Thanks. And then just one last quick data point. What do you think the -- you talked about replacement costs for the deals this year. What do you think the replacement cost on 101st is?

I personally, well, we built it up -- I'd say it's very close to $600.

That's helpful. Does that includes land?

That includes land. It could, it could be mid sixes.

Thank you very much.

Your next question is from the line of Steve Sakwa from ISI Group. You may proceed.

Thanks. John, I was wondering if you could talk a little bit about some of the developing opportunities that you are pursuing, and the types of returns that you would sort of be achieving, or trying to achieve on those versus the acquisitions that you are pursuing?

Yes. That's a good -- always one of those things that's always on my mind. And obviously, it depends a little bit if you own land, you might be willing to take a lower return than if you don't own the land, because obviously, you got the land on the books. We're sort of in that -- eight to high nines range on the proposals we are making right now. That's not going in on unlevered yield. And, when you look at that on an IRR basis, obviously, it adds to that. They are generally in the low double digits.

Then just trying to think through the implicit, I guess, rents on those buildings, I realize there might not be exactly comparable product around -- but how would the rents on those deals sort of compare to what tenants could get in the market place? I guess, asked another way, what kind of premium are tenants having to pay, or would they be willing to pay to go into a new building today?

Yes. The -- it's going to range, again, there's not enough data to -- I mean, I've got to give you a range, Steve. The -- it's anywhere -- we're looking at a deal right now that is around 80,000 square feet, and the premium is about a 30%, 28%, something like that, starting rent. It's a little bit higher than that, when you look at the bumps, because the bumps obviously goose it up a little bit.

And the issue there is the tenant just can't find what they want in the existing market that has the locational characteristics and so forth. On the biggest transaction, we're working at -- on right now, which is well in excess of $100 million, long-term build-to-suit, the premium is probably closer to 50%. And I'm talking about on triple net rents. But the reality is, there is no place these people can go, other than having a building built either by us, or by somebody else,

Okay, thanks. And the acquisitions, I guess, that are I guess, under contract and those that are pending, can you just give us a little bit of flavor for the types of sellers? Are these banks, are these just individuals that have mortgages coming due, that have no way to refinance? Can you just give us a little flavor for where they're coming from?

It is all over, frankly. We've got one former lender who is selling, that controlled the asset through the lending process. We've got one who is a private, high net worth. We have got another private high net worth. We have got an overseas buyer, and we have got a TIC. So, it comes from all over.

And then we also have a couple of situations, which has been the pattern on some of the smaller deals, where there is some equity, but there is a loan coming due. And, they don't have the wherewithal or the desire to replace the loan with something that is less, so they've got to put more money, so they are just basically confronted with an exit strategy that allows them to monetize their equity and move on.

Okay. And then just last question, maybe for Tyler. You talked that, it sounds like you will do dispositions this year. Can you give us a sense for what is in the guidance? I mean, how back-end loaded is it? Is this more of a 2012 financial impact versus a 2011 impact?

Yes, we didn't include it in the guidance. So, there is no dispositions in the guidance. But if it's -- as John said, we are certainly looking at that, and it could be very likely that we do something this year. But, given where we are in the year, it is going to be -- it is going to be back-end loaded. There's nothing imminent on that front.

I guess, maybe are you marketing? Are you actively marketing properties today, or is it just something that you're contemplating?

Properties for sale?

Yes. I don't know whether -- we got one is fairly sizable, that have we now listed it? And -- it's in process, so we would rather, we have a little situation where we've got to go to the tenant first. So, we are doing that, but that is a $100 million plus transaction. Or will be.

Okay, thanks.

You're welcome.

Your next question comes from the line of John Guinee from Stifel. You may proceed.

John Guinee, here. Quick question on Plaza at Yarrow Bay. I was there about a year ago, and it's clearly a 6.1 on 87% occupied makes a lot of sense. Probably a seven on stabilized makes sense. $358 a square makes sense. If you look at a -- your 80% of replacement cost, that implies about $445 or $450 a square foot. And it is a great location. It's a beautiful setting, but it is a fairly, generic physical structure. Can you give us a little more color on -- to get to $445 or $450 a foot, what sort of assumptions are you making for your land per FAR, your base buildings, your TIs, your soft costs kind of building up to get to that $450 number?

I guess, I can do that. We can talk off line in detail. But I mean land costs, we had $50 a foot, shell and core of $120 a foot, site improvements, 26, TIs $50, soft costs $82, financing costs about $50. And then parking for one -- 1.1 per 1000, about $55, so we get to the mid $400s , $430, $440 range. In addition there, and maybe John or Jeff wants to comment on the development -- the development

Yes, we have an opportunity for a fifth building, a four-story, 70,000 square-foot building on that site.

Is it already entitled?

Yes, it is.

Great, all right. Thank you.

Your next question comes from the line of Ross Nussbaum from UBS. You may proceed.

Hi, good morning, out there. A couple questions, first on the disposition front, John, is there any thought to look at monetizing some of the industrials, given that you've now gotten it -- at least the majority of the assets are fully leased now?

I toy with that in my head all the time, because it's obviously diminished with regard to the percentage of NOI that it contributes. And obviously, the thing in my head is that some of those assets have far more upside, not being industrial, in the future. And so, do we sell some of it, and cull some of it out, and keep it? That's one question that is in our mind.

And secondly, I always hate to sell something, when we just have taken a bath on re-leasing it. So, it's a question of what the price would be. But, let's just say, that -- and I realize I'm asking some questions of your question, Ross, so forgive me, it's something that we think about it. It could be better that we trade it. It could be better that we hold onto it. We are going through that, we regularly go through that. But we do not have a definite plan at this point, but let's just say that we want to be opportunistic at where we are in the cycle and make sure that we do sell what we want to sell, when it is appropriate to pull the trigger. And if I would criticize us, and perhaps others, now looking back with 2020 hindsight, I wish we have sold a lot of stuff back in 2006.

Yes, I know it sounds like your thinking is the same as mine, which is if it's a smaller percentage of the portfolio, now, should you be in the business at all?

Well, yes, we've never been in the logistics business. I think you know that. The stuff that we have is higher value, and it's -- there is a diminishing stock in Orange County, frankly. But, I think it would be safe to say that not only will that percentage of NOI be driven down because of acquisitions and/or lease up in the office portfolio, but I think it will be driven down by some of the individual sales that we are contemplating. And whether we do something in a larger way, like I say, we might trade some of it for something else that we think is going to give us more legs.

On acquisition front, of the $460 million and change that you've closed escrow and negotiations on, I'm curious, how does that compare to the size of the investment pool that you actually underwrote or bid on? What has been your hit rate? I'm guessing it has been high?

Well, yes, I think it is. But it's again, how you measure. I think you can also say it's low. I mean the reality is, we look at an awful lot of stuff. And we have added a bunch of analysts, and of course with Eli coming aboard and some of the other talent we have, we're looking -- and because there is so much more in the market, we are looking at a lot of stuff. A lot of that goes in the trash can immediately, figuratively speaking. And a lot of it requires further analysis, and whatnot. But, Eli, I don't know that we are keeping track like we did last year, because there it was -- we had 30 deals that we really analyzed. And I think ten that we made bids on, and eight that we closed, or six that we closed, or whatever. Do you have a sense, now?

I mean, it has always seemed to me that, if you look at ten with a relative degree of seriousness, to get one deal. And, you are really just flooding through a lot of them. And you look a lot more than the ten, to decide which ten you are going to look at seriously. And of those that you look at seriously, you get one or two of those. So, I mean the filter is pretty intensive, I mean, if you look at the packages that you get, you might look at 30 or 40 packages per deal you get. So, it's -- there is a lot out there. You have to find the stuff, that fits strategically, that has a chance, that you have a relationship, that has a chance of being priced in a level that you want, and then, ultimately succeed in getting that. So, it is a tough road. There is a lot of people running out there, and it's still a fragmented market, so that's a good thing for us, because you can find your right spots. But yes, we have to be very selective. And we are being very selective.

Okay and then Tyler, I might have missed this. The same store operating expense is up 13% year-over-year, what was driving that?

Well, that included the litigation expenses, the $0.03 a share of litigation expenses, because of the tenant issue were in property expenses.

So backing that out where does that get us on a more normalized --?

On a GAAP NOI overall same-store basis, our -- I think we were up 3.8%. It would have been 5.5% roughly, and on a cash basis, 1.4% to 3.7%, so 2% change in same-store numbers effectively.

So as we go forward for the rest of the year, the same-store expense number should be more normal, if you will?

Yes.

Okay. Thank you.

(Operator Instructions). Your next question comes from the line of Michael Knott from Green Street Advisors. You may proceed.

Hi, guys. Good morning. A question on just --if we take a step back and think about the increase in your occupancy beyond this year, how much harder does the path get to go from kind of 93 that you expect at the end of this year, to get to something more like 95, which I think you commented on in January, at your event in San Francisco? Has most of the low hanging fruit been taken out? Does it get a lot harder from here?

I don't think so. This is John, Michael. We've not leased, like the premium stuff, and the lousy stuff is -- you always have some lousy stuff in any portfolio. But, I think, when you take a look at driving our occupancy up, it's more a function of demand in the market. And I will give you a case in point, down at Mission City Corporate Center, which is a complex which is just around 300,000 square feet that we bought from McGuire, as I recall it was about 70%, 60%, something like that, leased when we bought it. We thought we would lease it up little bit faster, but there was some -- a couple other owners who were being very aggressive. Well, they leased up. Now, we have moved that up to where we have about 30,000 square feet left in that complex. So, we're closer to 90%. Is that right, Jeff?

Yes, mid 80s,

Mid-80s, and with deals of progress. And we are moving our rents up. And, we have the best space left. So, that's one example. But, here in LA, we have a little space, at Westside Media Center, which is absolutely spectacular space. And, we try to make sure that if there a bunch of people out there competing with somebody, or competing for a tenant. And that tenet is driven just by price, you have to determine whether you want -- want to go hard after it early on, or whether you want to wait and let the market clear little bit back. And so, it is all over the lot, but I think it is more a function of just the demand.

And the demand we're seeing across our markets has been very good, very good relatively speaking, pretty good historically speaking. It's certainly getting better. So, I think it won't be even. And it won't go from 93 to 93.5, to 94 to 94.5. It will -- but it's like a, it's just like a graph, it will go --trend up, and we will go up and down a little bit. But unless something really horrible happens, I'm feeling pretty comfortable we're going to get back to those mid-90s. I can't tell you exactly when, but I certainly feel like we're getting there.

Okay, thanks. And John, your West LA commentary seemed a little more positive than it had in the past. How you feel about that market and the demand profile there compared to other -- your other LA submarkets like El Segundo, Long Beach, etc.?

Well, I'm not a naysayer by any stretch of imagination on west LA, but I think that -- you got to be -- we are in a lot of markets. And we've got to be honest with ourselves about where any market is, and they don't all recover, and they don't all go down at the same time. LA, for a number of years, has not had positive absorption. This is the first quarter, so we really like that. And, we are seeing more activity, and we really like that. We haven't seen rent, rents anywhere near where they were couple of years ago, three years ago, it's going to take a while to get to that point.

But, we are always enthusiastic, when we're seeing deals in the market, because honestly, in this business, it requires lots of tenants in order to fill up space, and at a lot more tenants in order to move rents up. And, that's going to be uneven throughout our portfolio, and throughout the various communities in which we operate. And we're seeing it now, and in LA, we're seeing increased demand. We're seeing positive absorption. I am big fan, a big advocate of West LA. I love it. I'd like to see it get back to where it's -- everything is a four and a five and a six on a monthly rent numbers. I think it's going to be a while for that to happen.

In terms of the other LA markets, that was your question. We've done just fine down in Long Beach and El Segundo, with what we have complete, we are essentially all leased. We've got the 2260 building, which is the building some people referenced, I don't like to use the old Hughes building or the old Boeing building, because with what we have done to it, it's probably best building in all of the South Bay right now. And, I would invite anybody that is on the phone call, the next time they are in LA, we'd love to take you through it, and show you what we've done there, because it's pretty spectacular.

We are very enthusiastic about what is going to go on in that market, particularly with that asset, because when you look at product segmentation, market by market, and you look at what has been the giveback by the aerospace or defense contractors in the South Bay, most of that space is not stuff that any of the tenants we're talking with would want to inhabit.

And then, in terms of, I'd still -- I think probably one of the weaker markets, obviously, the Ventura market is not strong, out on the 101, of course, we are in Calabasas that we like a lot, we're doing okay with. We, in Westlake, which we're doing okay with, we're not in (inaudible) center in those markets, there's quite a bit of vacancy. So, I think the 101 market is starting to do better. It's just not being -- there's not a Countrywide out there, that's pushing occupancy and pushing rents through the roof as there once was.

Great. Thanks a lot, John.

Okay. Anybody else?

Yes, your next question is from Dave Rogers from RBC Capital Markets. You may proceed.

Hi, it is Mike Carroll here with Dave. What is your outlook for market rents, and what occupancy rate would you feel more comfortable to push rents higher?

Well, it depends, because, it's not just occupancy; you really have to look at it from a product segmentation standpoint, which is if -- let me give you Delmar as an example, okay? Down in Delmar, the lion's share of the -- it's a 17%, both direct and indirect vacancy rate, and 85% of that is space that is 10,000 square foot or under. So if you're -- unless you have the best of 10,000 square feet available, you're just in a commodity business there, and unfortunately, we are not. If you have a larger space, then your rents probably on an effective basis is going to be close to twice on an effective triple net what it would be, as measured against a 10,000 square foot space.

So, we think we will see -- we're starting to see some rents move up in Mission Valley, we're starting to see it on the I-15, we're starting to see it in Sorrento Mesa, in the larger spaces. In Delmar, and almost all of the markets, we are certainly seeing it up in San Francisco, in the Soma district. So it 's going to be -- it's not just about vacancy rate, it's obviously about the quality of space, and the quality of the location.

The brick and timber, as an example that we bought at 250 Brannan Street. We bought that with 77% occupancy, we forecasted a fairly substantial period to lease the remaining space. We have a letter of intent, we did quite a bit better on run rate, quite a bit better on TI, quite a better on the lease up period, and it was because it is an asset that everybody wants to be in. It is very much sought after. So, it is sort of market by market, and really looking at product segmentation. And I don't know how else answer that, because it's a, no offense, it's sort of a generic question, and it doesn't lend itself to a generic answer.

Okay, great. And then, would you start any development projects on 100% spec?

Oh, it would have to —again, we really would be looking at product segmentation, and taking a look -- for an example, in San Diego, if there was a 60,000 square -- if there was nothing available that was 60,000 square-feet, and a bunch of people that wanted 60,000 square feet, and we could develop one, and have appropriate price point, then we might consider doing something like that. If you are talking about 0.5 million square-feet in today's market, not in these shoes.

Okay great. Thank you, guys.

And there are no other questions in the queue, I will turn the call over to Tyler Rose for closing remarks.

Thank you for your interest in KRC. Have a good day.

And ladies and gentleman, this concludes your presentation. You may now disconnect.