Kilroy Realty Corp (KRC) 2011 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter Kilroy Realty Corporation's earnings conference call. My name is Marissa and I'll be your coordinator for today. At this time all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference.

(Operator Instructions)

As a reminder this conference is being recorded for replay purposes. I would now like to turn not conference over to your lowest for today's call, Mr. Tyler Rose, the CFO. Please proceed.

Morning, everyone. Thank you for joining us. On the call 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 some of the information we well be discussing 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 7 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. Thank you for joining us today. Activity in our Key West coast office markets continues to build as we had another quarter with strong leasing results and improving fundamentals. We continue to expand our West Coast franchise, closing on 4 acquisitions during the quarter with an additional 4 in the pipeline.

We also have strengthened in our management team in our Seattle region. Our disposition program is underway with 3 projects currently in the market. We've made progress on the redevelopment front with the execution of 100,000 square foot LOI in San Diego to renovate an existing vacant building and incorporate 1 of our development sites into the project and our leasing momentum continues to accelerate based on the level of leasing activity so far in the third quarter.

Finally in terms of funding we completed a bond financing, amended our bank line to improve pricing and terms, and just yesterday announced a $200 million ATM program. Let me review these activities in more detail.

In terms of leasing, we are seeing increased demand in many of our markets and during the quarter we signed approximately 360,000 square feet of new and renewing leases. We had 445,000 square feet of in-place LOIs at the end of the quarter.

Since the end of the quarter we have signed 6 additional leases totaling approximately 160,000 square feet and now have 30 in-place letters of intent, totaling over 900,000 square feet. Occupancy in our stabilized portfolio decreased slightly at the end of the second quarter to 90.2%.

This was due to the 200,000 square feet lease expiration in Ventura County that we mentioned on last quarter's call. Year-over-year occupancy was up more than 500 basis points.

In terms of acquisitions we closed on four acquisitions in the second quarter, are in escrow on 3 more and are in final negotiations on another property. Each of these properties is located in top submarkets with sound underlying fundamentals. The acquisitions include a combination of well-leased and value-added opportunities that will allow us to increase value over time.

Our 4 completed deals include 1 we discussed in our last call, a 4-building, 280,000 square foot office complex on the east side of Seattle known as the Plaza at Yarrow Bay. We paid just over $100 million for the complex and have already moved the leasing to 90% since closing.

Here are some of the details on the other 3 completed deals. Key Center is a 488,000 square foot, 22-story office building located in the Bellevue submarket of Washington. It is the premier multi-tenant office property in this submarket. The building was completed in 2001 and is subject to a favorable long-term ground lease.

We paid approximately $250 million or about $440 per square foot for the property. The in-place cap rate is approximately 5% based on occupancy of 88%. The stabilized cap rate is expected to be approximately 6%. It is LEED gold certified and has a roster of high quality credit tenants that include major tech and professional services companies.

This acquisition is another step in further expanding our platform on the east side of Seattle. The underlying submarket fundamentals are strong with 5 consecutive quarters of positive net absorption.

In San Diego we completed the purchase of 174,000 square foot office building located at 10770 Wateridge Circle in Sorrento Mesa. The building is located in close proximity to several of our existing properties in this submarket and is currently 98% occupied. We paid approximately $33 million or $188 per square foot for the building. The in-place cap rate is 8%.

Our fourth completed acquisition is a 127,000 square foot office building located at 4040 Civic Center Drive in San Rafael which is extremely supply constrained submarket a few miles north of San Francisco in Marin County. We purchased the property for approximately $32 million or $254 per square foot which represents a cap rate of approximately 6.1% based on 93% occupancy. The property is approximately 60% leased auto desk and has limited rollover in the near term.

With the closing of these 4 acquisitions we have now purchased a total of 5 office projects year-to-date adding approximately 1.2 million square feet to our stabilized portfolio. We paid an aggregate purchase price of approximately $413 million. On average the in-place cap rate was 5.8% with an average occupancy of 89%. The estimated stabilized cap rate for the 5 assets is 6.6% and the estimated average IRR is approximately 9%.

In addition we have 4 pending acquisitions that have a total aggregate purchase price of approximately $266 million. We will be assuming approximately $83 million of secured debt in connection with these acquisitions. Two are located in northern California, 2 are in Southern California. The average in-place cap rate is approximately 5.1%, based on 87% occupancy. The average estimated stabilized cap rate is 6.7%.

Three of the 4 are value-added opportunities with both occupancy and renovation upsides while the fourth is fully leased but provides an attractive 7% going -in return. On average we anticipate high 9% IRRs based on current projections. We expect to close these current transactions in the third and fourth quarters subject to customary closing conditions.

With regard to our capital recycling program, we are currently marketing 3 unencumbered projects for sale, 2 in San Diego and 1 in Los Angeles. The estimated aggregate sales price is approximately $185 million. Tours are currently underway and we've received good feedback so far. We expect to have more to report on our next call.

On the development front our negotiations continue with several potential corporate tenants in technology, healthcare and financial services that are interested in new facilities. As I mentioned, we have recently executed an LOI to lease an existing 100,000 square foot office building in Sorrento Mesa. The project will undergo significant renovation including adding lot 7 of our development pipeline into the campus. Occupancy for this tenant is projected to be in the third quarter of 2012.

Now let me review our individual markets. The San Diego region experienced positive absorption for the seventh consecutive quarter. Vacancy rates have fallen in most San Diego submarkets and has now dipped below the double-digit mark in the Sorrento Mesa Class A office market.

Job growth remains modestly positive here and we are now seeing some positive rent growth particularly in Del Mar and Sorrento Mesa. Demand is diversified across several industries including technology, fire and life science. At the end of the second quarter our portfolio in San Diego is 91% leased.

Further north, the Orange County office market continues to recover with vacancies declining due to positive net absorption for the fourth consecutive quarter. Rents here remain soft.

The Orange County industrial market also continues to improve with a fifth consecutive quarter of positive absorption, or close to 1.1 million square feet, marking 1 of the strongest quarters since the fourth quarter of 2005. Lease rates held steady from the prior quarter and remain about 35% below the peak in early 2008. Our Orange County office portfolio -- excuse me, was approximately 93% leased and our industrial properties were 100% leased at the end of the quarter.

Continuing north, the greater LA metro area has been slower to gain sustained traction, 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 second quarter. In west LA market demand and tenant activity picked up with rising interest from a range of entertainment, tech and media firms.

Net absorption was positive and rents were modestly up from the first quarter. Occupancy in our Los Angeles portfolio is down due to the move-out in Ventura County. Our Los Angeles portfolio is 87% leased at the end of the quarter.

Moving to northern California, San Francisco continues to outperform. The amount of available and vacant space is the lowest in more than 2 years. The strong and steady leasing activity in our south financial district submarket continues to be primarily driven by technology and media tenants.

Additionally rents have increased more than 6% quarter over quarter. On an annualized basis our San Francisco portfolio now represents 12% of our NOI. Overall our San Francisco properties were 97% leased at the end of the quarter.

Finally the east side of Seattle maintained its steady progress for the fifth consecutive quarter of positive absorption totaling over 500,000 square feet in the second quarter, more than any other submarket in Puget Sound.

Technology companies accounted for the majority of leasing activity, projected job growth in the Seattle area is expected to outpace the country in both 2011 and 2012. With the recent completion of our third acquisition on the east side we've expanded our platform in the Northwest to almost 900,000 square feet. Our properties there were 91% leased at the end of the quarter.

Continuing our strategy of managing our business with local expertise, earlier this year we hired Mike Sanford to run our Bay Area and Seattle operations. Given our continued expansion in both regions, Mike Sanford will stay focus on growing our Bay Area business and we have just added Mike Shields to the KRC team, an experienced Seattle real estate executive to run our Seattle operations.

They both will be responsible for leasing, acquisitions and development in their respective regions. Mike Shields has worked in Seattle real estate for the last 15 years at firms including Spieker Properties and EOP. He will be joining us in September. That's an update on our market conditions and activity.

In summary, our markets continue to improve, although some more quickly than others. San Francisco clearly is outperforming most of the markets in the country.

The Puget Sound area seems poised to follow closely behind, and San Diego has experienced a significant rebound from a year or 2 ago. Subject to the execution of several deals throughout our various operating regions we expect to have a very solid third quarter in terms of leasing.

Looking back at the acquisitions we have closed since midyear, we are very pleased with the performance of our acquisition portfolio. We were ahead of the curve in acquiring high-quality well-located office properties at favorable prices. We remain disciplined in terms of new acquisitions and are confident that it will continue to be value-added opportunities on the West Coast.

In addition, we believe that development may become more meaningful for us sooner than anticipated. Finally, while we remain optimistic about our markets and opportunities, we are also mindful of the macroenvironment in which we all operate and will continue to maintain a strong balance sheet. With that I'll turn the call over to Tyler who will cover our financial results in more detail. Tyler?

Thanks, John. FFO in the second quarter was $0.52 per share including about $0.02 per share in noncore acquisition-related costs. Stabilized occupancy at the end of the second quarter was 90.2% down from 90.8% at the end of the first quarter. As we reported last quarter, that decline reflects the impact of a 200,000 square foot lease in Ventura County that expired during the quarter.

The tenant ultimately chose to vacate the entire property and we're in the process of remarketing it. We have assumed it will be vacant throughout 2011. On a year-over-year basis our portfolio occupancy is up 510 basis points from a year ago. By product type industrial occupancy rose to 97.6% at the end of the second quarter.

Office occupancy dropped to 87.9% from 89%. As of today, our properties are 93% leased. We saw further improvement in same store NOI in the second quarter. It was up 7.1% on a GAAP basis and 9.9% on a cash basis. For the first 6 months of 2011, NOI rose 6% on a GAAP basis and 5.9% on a cash basis. The big driver of these improvements is substantially higher average occupancy of approximately 700 basis points.

Rents on office leases signed in the second quarter were up 1.1% on a GAAP basis and down 6.1% on a cash basis. For industrial leases GAAP rents were down 21.2% and cash rents were down 25.9%. Our industrial portfolio's NOI now accounts for about 9% of the company's total NOI.

By region, rents on leases we signed in LA during second quarter were up 4.6% on a GAAP basis and down 4.2% on a cash basis. In Orange County rents were down 18.1% on a GAAP basis and 20.2% on a cash basis and in San Diego rents were down 13.5% on a GAAP basis and 14.9% on a cash basis.

As of the end of the second quarter we had approximately 445,000 square feet of LOIs outstanding. Approximately 2/3 are for office leases and half are new leases. Across these leases rents would be up 1.8% on a GAAP basis and down 8.8% on a cash basis. We estimate that rent levels in our overall portfolio are slightly under 10% over market.

Our lease expirations for the remainder of 2011 total about 200,000 square feet or roughly 1.6% of total expiring leases in our lease portfolio. Also in July, we started the redevelopment of half of the 98,000 square foot project in Long Beach previously occupied by DeVry University. DeVry has re-leased half the building and we will redevelop and modernize the space in 2 phases.

Turning to our recent capital transactions, during June, we amended our $500 million dollar unsecured revolving credit facility. We extended the maturity date by 2 years to August 2015 and reduced the interest rate spread by nearly 100 basis points from 2.675% to 1.75% and the facility fee from 57.5 basis points to 35 basis points.

Early in July, we completed the public bond offering of $325 million of 4.8% senior unsecured notes that mature in July 2018 for net proceeds of approximately $321 million. We used the proceeds to pay off the $245 million balance on our bank line. We currently have $80 million of cash and 100% of our debt is fixed rate.

As John mentioned earlier, we also announced the $200 million ATM program to help manage our balance sheet and keep our credit profile strong as we continue to pursue acquisition opportunities. From a capital requirements standpoint, for the remainder of the year, assuming we complete the pending acquisitions and dispositions, pay off our 1 remaining debt maturity and everything else stays the same, we would end the year with about the same leverage and nothing drawn on our line.

Now, let's discuss updated guidance for 2011. To begin I will 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 reflect information and market intelligence as we know it today.

Any significant shifts in the economy or a market swing 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. Our projected year-end occupancy is 92% down a point from last quarter. This revision reflects the impact of our pending acquisitions and disposition properties.

The disposition properties are all 100% occupied and our pending acquisition properties on average will be 87% occupied at closing. Given our significant level of LOIs we anticipate 2012 occupancy to continue to rise.

In terms of our pending acquisitions, our new guidance assumes that the timing and closing of transactions has flipped about 3 1/2 months on average from last quarter's estimate. This has about a $0.03 negative impact on 2011 earnings guidance.

We also estimate that second-half acquisition-related expenses for our pending acquisitions will total approximately $0.03 a share. This is consistent with last quarter's guidance. We also assume we will complete about $185 million of dispositions early in the fourth quarter.

In terms of G&A, first-half costs totaled approximately $14 million which is right on target for our $28 million initial annual projection. Given our growth in associated staff additions in San Francisco and Bellevue, our run rate will be about $0.01 or so higher for the second half.

We're taking all that into consideration. We are providing updated 2011 FFO guidance that tightens our previous range of $2.22 to $2.36 per share to a new range of $2.22 to $2.29 per share. That's the latest news from KRC. Now we'll be happy to take your questions. Operator?

(Operator Instructions)

You have your first question from the line of Jamie Sullivan from Bank of America Merrill Lynch. Please proceed.

Thank you. Just I guess quickly first on the guidance, Tyler -- so the change in your assumption suggests there's no change to your same-store outlook. Is that correct?

Well, yes. The same-store, what we said I think at the beginning of the year, was we would be around 5% for the year and I think we're still in that 4% to 5% range for this year. There's a higher same-store in the second quarter; I don't think we're going to maintain that through the full year.

Okay. And then can you talk a little bit more about some of the occupancy loss in the quarter, how your conversation's going for the space in Ventura and then some of the other buildings where you lost space?

You want to cover that?

Yes. This is Jeff. Basically the 200,000 square feet that we lost in the Camarillo project -- we continue to show the space and have tours, so more to come. And then some of the other losses are really sort of scattered throughout Long Beach, El Segundo and we are seeing good activity and we're confident we'll be able to release that space. So really the main loss was in the Camarillo project.

And you said you guys are selling it vacant through the end of the year. Does that mean you think there's a good chance it will be early 2012?

Hard to tell at this point. Obviously it depends on activity and tours, so haven't made a projection at this point.

Okay. And then, John, in your prepared remarks you had talked about a 9% IRR on a lot of these acquisitions. Can you just walk us through the calculation to get there, kind of what are your assumptions?

Tyler, you want to go through the numbers there?

Yes. I think you're probably thinking of rent growth. The way we've been modeling -- every deal is different, every market's different, but the first year we assume no growth from the market rent and then I believe on average for all of our acquisitions this year -- we're in San Francisco and Seattle, so some good growth markets. We have a 5% rent growth number and then it sort of bounces around, but on average, over the 5 year period, the first 5 year period in that calculation, we average around a 24%, 25% rent growth for that period. And then depending on the cap rate on the exit, it ranges from 6.5% to 7%. Is that right, Eli?

Yes, 6.5% to 7.5%. We calibrate that against what we think replacement cost is and where the in-place rents are at the time of sale compared to the market at that time and take a couple different ways of looking at the exit prices to make sure they're rational.

So in term of raising the cap rates are there markets where you are thinking cap rates go lower than here and that's part of your IRR?

No, no. They're usually higher. Sometimes they're the same. If we're starting at a very, very low in-place now and we're still under market when we sell it, but that's the most aggressive we've been is the same and oftentimes either 50%, 100% or even 150% higher, so --

And finally what gives you comfort on 25% rent growth over 5 years? What are you basing that on?

I think if you go back and you look at the market that we're talking about, we're talking about the east side of Seattle for all of these and you look at 2 metrics. One is you look at prior recent peak rents and you also look at reasonable replacement rents to put new product on the market, call it at an 8% yield, development yield, that would suggest even after 5 years assuming even there's ups and downs during that period that after a 5-year period you're still at a 15% discount to previous peak rents and to replacement rents and so, you know, we're not -- even though we're a lot of these growth periods we're not even getting them up over a 10 year period to where their previous peak rents were.

So, if you look at some of the markets and the different brokerage houses are all over the place in terms of what their projections are, but they certainly -- you'll see in Seattle and SoMa, you'll see people projecting 10% per year for the next couple of years. You'll see people projecting years of 15% and those are the kind of jumps that have been typically experienced in that market, even 20% jumps in those markets when things get really warmed up. I'd say we've been materially more conservative than that below all the brokerage houses and calibrating where rents get to based on common sense, previous peaks and replacement rents. So does that answer your question?

Yes, that's very helpful. All right. Thank you.

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

Hi, thanks, good morning out there. Tyler in, your comments you talked about being 93% leased today. I just wanted to make sure -- is that including the industrial or is that just on the office?

That's the whole portfolio, whole portfolio.

Portfolio. That's compared to the 90.2% occupancy rate?

Correct.

So basically your year-end occupancy target of 92% is, in effect, most of that leasing takes occupancy by year-end?

Yes, most of it, yes, exactly. There's lots of in and outs, right? In that projected number we have dispositions, we have our pending acquisitions, we have our expirations and we have our leasing, so lots going on in that number, but yes. In terms of the leasing numbers we're assuming most of that moves in this year.

Okay. Separately on the TI and CapEx front can you give an update to what your thoughts are there for the full year?

In terms of total costs?

Correct. It was running it looks like a little over $11 million in the quarter. I'm trying to get a sense for if that number's going to start backing off or if you expect to terminate around that level?

Yes. Some of it depends on the leasing and some of the LOIs we're working on, so that number can be somewhat volatile. I think we said last quarter it was $45 million to $50 million I think we're still in that range for the year total.

And it looks like you've done just under 20 or so. It would be a little higher than the first half pace in the back half of the year?

Yes. I think we think the third quarter particularly will be higher and more moderate in the fourth quarter, but that again really just depends on leasing and negotiations. It's hard to project. Thanks very much.

And your next question comes from the line of Michael Bilerman from Citi. Please proceed.

Hi, Thanks. It's Joshua Attie with Michael. John, you mentioned having a 900,000 square foot leasing pipeline. Could you just clarify that number and put in the context regards to the 445,000 square feet of LOI you had at the end of the quarter?

Sure. At the end of the second quarter we had 445,000 square feet in LOIs. That was 30 different transactions. Some of those have been converted to leases now and at present since taking a snapshot right now we have 900,000 square feet of letters of intent, still representing about 30 transactions, some of them, a portion of that was holdover front that was LOIs in place at the fourth quarter and a portion of that is LOIs signed since the fourth quarter. Those are up and down the coast throughout the portfolio.

So does that mean some really large leases were signed between the end of the quarter and today?

Well, we're talking about LOIs in the 900,000 square feet. We signed 160,000 square feet of leases, 6 different transactions, 162,000 square feet since the end of the second quarter and we now have 30 different LOIs totaling 900,000 square feet and --.

I'm just trying to bridge the gap between the 445,000 square feet you had at the end of the quarter and the 900,000 square feet that you have today. It sounds like is it 445,000 square feet, Then you signed 160,000 square feet, so that drops down to 285,000 square feet and then you pick up another 600,000 square feet of LOIs?

Yes. Tyler, you want to go through the --

That's exactly right, Michael. There are ins and outs here. So since June 30 we signed some leases which reduces the number of LOIs and then we signed some new LOIs which increases the number of LOIs.

And what are the term -- when you look at that 900,000 square feet which is obviously relative to a commencement of 300,000 square feet to 400,000 square feet a quarter, at least in the quarterly in this past quarter the term was pretty -- was actually the lowest it's been in a little while, but the CapEx obviously has remained high. Can you talk a little bit about the characteristics and the metrics on that 900,000 square feet?

Let me -- as you can appreciate with LOIs we're always a little reluctant to get into much specificity just because they're not signed yet, but I can tell you that the term for the great bulk of that is substantial and think of substantial as in excess of 10 years.

And, Tyler, on the guidance does the guidance assume any ATM equity issuance and what does the guidance assume for the cap rate on what you're selling?

Well, on the cap rate for what we're selling we'd really rather not get into that. Obviously we're in the market negotiating with buyers and to provide that information wouldn't make sense for us. So we'll stay away from that question. On the ATM, our guidance assumes modest, very modest use of it, but, we have the balance of our short term earnings with managing our leverage. So we may use that depending on again what capital requirements we have. As I mentioned in my comments, we don't need to use it in order to end the year effectively on the same leverage, but we might want to lower our leverage in any event and so if we did, there could put a little pressure on that, on that guidance.

Okay, thank you.

And your next question comes from the line of John Guinee from Stifel. Please proceed.

John Guinee here. John Kilroy, quick question on your future development pipeline. One Paeo Del Rey got $117 million cost to date for current entitlements of about 500,000 square feet. That's $234 per SAR. Your basis in that one is about $5.1 million per land acre, also. Your other big land position, Santa Fe Summit, $77 million, 600,000 square feet of entitlements, about $129 per FAR and about $3.5 million per acre. How should we look at the current value of that land and what's your timing on getting those things underway?

Well, One Paseo, as we've talked about for the past1.5 years, 2 years we are going through a re-entitlement effort and that would increase the entitlements many fold over what -- you've mentioned the 500,000 square foot number and that's for a mixed use project. Where we stand on that as we have received favorable comments from the traffic, we should have our preliminary EIR out this summer. We've got the support of most of the homeowners, so we're feeling good about that. So I think that when we take look at the values of those properties, I think we're going to do quite well on them.

How about timing on Santa Fe Summit, anything there?

Well, we're having some discussions with folks with regard to Santa Fe Summit. Depends upon, obviously what we do, how much pre-leased we go with there. We've got a couple different discussions going on with different users in the 100,000 to 200,000 square foot range, each. So I just don't want to in today's market get into establishing a time frame, John, to start, but when we take a look at where the markets have gone and we take a look at what the demand is that we're seeing and we look at the discussions that we're having and we take a look at other development that others have done or are starting to do that's pre-leased, that's why I make the comment. I think it could be sooner than later. Now therein lies, you know, the $64 question, what's sooner and what's later? If this was the late '90s or the mid-2000s, I would think we'd be under construction with something sometime in the first half of next year, but I'm not willing to go there in this kind of macro environment. There's just too many things that could influence that thinking.

Great, thank you.

You're welcome.

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

Hi, I have a couple questions. Regarding your 3 development properties what are the yields you're looking at right there? And also you provided some capped interest guidance about $2.5 million a quarter. I'm just wondering where that stands with your current guidance.

Yes. The capped interest guidance is maybe a touch lower than that, maybe $2.2 million a quarter right now for the reminder of the year. And the other question, I'm sorry, what was the other question?

For the 2 redevelopment projects, what yields are you anticipating?

Yes. Roughly the redevelopment returns we're looking at are in that 8% range, 8% to 9%.

And then also if you start looking at your new guidance I think we calculated that is the second half of $1.18, $1.19 versus the first half of $1.07. Is this a good way to start thinking about 2012?

Well, yes. We were a little hesitant -- well, very hesitant to provide 2012 numbers at this point, I guess, but --

Sure.

Our portfolio is changing, right? Our occupancy is going up. We've had a fair amount of free rent. Some of that's going to be burning off. We have a lot of leasing going on. The timing of that starting is going to impact next year's numbers. So it's a complicated calculation that we'll get more into as the year goes on in terms of other calls, but, our sense is it's definitely going the right direction.

Okay. And finally with regard to your dividend when do you sort of expect -- you report about $0.30 on AFFO and your dividend was at $0.35. When do you think you can achieve some kind of parity there?

We've said before that I think by the fourth quarter we'll start covering hopefully and then it will improve into 2012. That somewhat depends again on leasing. We just signed some big LOIs which depending on when the TIs come in for those deals could impact that number, but from sort of an operating perspective the numbers show us covering fourth quarter early next year kind of thing.

Okay, great. Thank you so much for the color.

Sure.

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

Hey, guys, question for John and Jeff. Can you just talk maybe about the tenant mindset given all the negative headlines about the economy and, of course, all the uncertainty coming out of Washington and Europe as well?

Jeff, you want to cover that?

Sure, Michael. Basically what we're seeing is good activity across the portfolio and tenants seem to be stepping up and making real estate decisions. I think there's some concern that rents are going up, so we're seeing pressure on locking in deals. So, activity is good. Confidence seems to be good and we're optimistic as we look up and down the coast.

Okay, thanks and then, John, question for you, what is your thought process on staffing up in Seattle? I guess maybe it seems to imply a little bit of a greater growth trajectory than maybe the prior strategy of managing that out of San Francisco. Is there anything to read out of that? Do you think you'll get even bigger there sooner then maybe you thought?

There's been some deals that have gone on there recently that we liked. In terms of physicality, the asset and location, all that sort of stuff. It got very pricey, extremely pricey. I can provide more color on that, if you're interested. The hiring of Michael Shields, I think what you saw with us years ago when we bought into San Diego and then became active developers there is we don't know how to do our business well unless we have really intelligent local expertise on the ground supported by the capital structure and development structure and so forth from corporate.

I still think that real estate is inherently a regional or local business and you end up seeing better deals, more deals. You end up getting better opportunities across the board when you have boots on the ground and so hiring Mike Shields is both an endorsement for, at least by us, of what our strategy is there and what we think of long term. But in terms of acquisitions we're going to be opportunistic and I think we're clearly seeing more a sway if you will which we signaled a little bit over the last call or so towards value add. The core funds that are out there buying are really, really pushing the envelope in some of the underwriting in my view. So we'll be opportunistic.

If something comes up in the core that we like and we can afford to pay for it then we will. If we can't, we won't. So yes, we want to grow there in a disciplined fashion with the right kind of assets and the right kind of markets with the right kind of yields and in the absence of that, then we'll just wait until we can. In terms of development we're obviously we don't have anything going on right now to buy land there, but that could come in due course when, again, we see the right reading in the tea leaves.

Okay, thanks. That sounds like a good answer. And then just sort of similar, do you have a target weight in mind for sort of San Francisco and Seattle either individually or maybe together?

No. I've heard some people say that we're trying to reduce San Diego by buying elsewhere and I would characterize it differently. We like San Diego a lot. We obviously have a big development pipeline there, and as I've kind of thought about it, I sort of see San Diego as plus or minus 20% of the size we are today there. That can change at any given time based upon development or acquisition or a disposition, but if you sort of think of it as a continuum over time, I think that's probably a safe way to look at it.

In terms of San Francisco and Seattle, we really like the SoMa area. We've made some terrific buys there early on and with our recent activities. We've seen the rent goes up. The credit profile of the tech tenants and media tenants has substantially increased from past cycles, a lot of really first class names, so we like that and so we'll grow there as circumstances permit. Same thing in Seattle. I sort of look as this, Michael, in kind of big broad strokes of the Company is probably going to be over time 50% north of LA and north goes to Canada, I guess, theoretically and 50% is in Southern California just because Southern California is such a giant area. Now how long it takes to get there, who knows? And are those in hard and fast numbers? No, but sort of that's the way it kind of feels for me.

Okay, thanks. That's very helpful. And then just one last question, if I may. I guess maybe this would fall into the San Diego, maybe minus 20% side of things, but why sell in San Diego now? What's kind of your thought process there? Is it purely just re-weighting your portfolio there or is there something in particular? I know you probably can't say.

Well, we've got 3 assets that we've gone in the market with now, 2 in San Diego, 1 in LA. Those are great assets. I'd be happen to continue owning them, but if you're going to sell, something you've got to pick some and these were ones that we thought were appropriate. We think they're high demand assets and as you've heard us say before, we're not in love with selling stock. We got to operate our company the correct way and so as we look at the appropriate balance -- I think you guys know me well enough I'm not a hard right or a hard left kind of guy. I like a little bit more down the fairway even though I'm not a golfer, but it seems like if we've got great opportunities to reposition the capital. We've got to sell something and the assets that we're talking about today we think are good candidates and I'm sure we'll have other candidates. These are just ones that we thought were appropriate at this point in the cycle.

And you thought those were more appropriate than the industrial portfolio or is that sort of not on the table today?

Well, no. I don't have -- no offense to any of anybody out there, my wife sometimes telling me I'm not as PC as I should be. I don't have a mother fixation about any particular piece of property. It's not like we gave birth to it by building it or developing and improving it. So I look at industrial as we look at it, we're thinking about our industrial. As Tyler mentioned, it represents 8% or 9%, Tyler? Now --

9%, yes.

9% of the company's NOI. It could be that we decide that we want to trade it or sell it or sell some of it. Some of that industrial has some real upside with regard to, not only improvement in rents over time because it's -- a lot of it was repositioned during downturn, but some of it has some real upside with regard to future development whether it's a change in the zoning and/or added square footage. So we want to be thoughtful as we take a look at industrial as to how we --what should we sell? Should we sell it all? Should we sell a portion of it? More to come. But let me say that we look at acquisitions and dispositions in a very disciplined way across the company to figure out what's the appropriate size of things, of dollar volume to sell and just as we look at it what's the appropriate things to buy.

Thanks, John.

You're welcome.

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

Yes, thank you, just a couple follow-up questions. On those LOIs, John, are any of those related to future assets or are they all related to existing properties today?

They're all related to properties we own today.

Okay. With regard to redevelopment, you're doing 1 project now, 1 or 2 and do you see more opportunities to do that in your portfolio to get the returns that you'd like to see or will value-add external growth be the best way to capture that going forward?

Sorry, Dave. I didn't know if I didn't hear it right. Can you restate the question?

Sure, happy to. I guess, with regard to your redevelopment opportunities, do you feel that in your portfolio today you have a number of redevelopment opportunities to increase rent, offer extra opportunities, obviously for tenants, or will you do value-add acquisitions as the alternative to perhaps redeveloping existing assets?

We'll do both. We're agnostic with regard to where's the -- as you've seen in the past we'll acquire when it makes sense, we'll develop when it makes sense, we'll do neither if neither makes sense. We like repositioning our existing assets when we can get the right kind of returns and so forth and as I just mentioned with Michael Knott's question, we think we have some real upside in industrial just as we have with several of our office, and we're constantly looking at how we can change the mix of entitlements as well, such that we can improve the valuation. Case in point is that you've seen from us over the years is being able to take properties that were entitled either existing or land for office and get -- obtain added entitlement for MOB and be able to do some very sizable and attractive MOB transactions. So you'll see more of that as the opportunity presents itself.

What percentage of your portfolio do you think has that opportunity today or what might you be working on?

I don't know what that percentage is and I don't want to really guess. I'm happy to address that question in our next quarterly conference call because I think that's the next opportunity we have to talk to everybody in a public way, but I just don't have that number on the top of my head.

Okay. That's fine. Last question maybe for Jeff, the leasing economics for commencement in the second quarter obviously were a bit weaker from what showed up in the supplement. Can you give us some sense of when those deals were signed. Were they more historical deals? Was there something about those that were unique and have you continued to be as aggressive with the LOIs that you're talking about maybe not giving numbers or should we expect that the leasing economics improve in the second half.

This is Tyler. Maybe I can take a shot at that. Basically you're saying the leases that commenced during the quarter, when did we sign those? And usually it takes 3 to 6 months. So those deals were probably signed late last year, maybe early this year. And as you saw from our -- I think I reported in my comments that the leases we signed in the second quarter had better lease economics from a change in rents perspective, slightly up on a GAAP basis down about 9% on a cash basis and we've been saying our portfolio's about 10% over market. So those tie in.

We do sense that those numbers are getting a little bit better, but it is taking time for those to float through. And on the TI perspective -- TIs on an absolute basis were actually down a little bit quarter over quarter, but when you factor in the length of the lease on a per year basis they were higher. And I don't think that's any trend necessarily, but -- so there's a lot moving and going on in those numbers, but we do see a slight improvement in lease economics, but it is slight.

Okay, great. Thank you.

And your next question come from the line of Sri Nagarajan from FBR. Please proceed.

Thank you and good morning, good afternoon. Question. You obviously had the LOI of 900,000 square feet obviously a lot of questions on that, but perhaps to ask it a different way. How much of this is really in the Southern California markets versus Seattle given that you have a 90% lease portfolio there in Seattle? Just trying to understand the differential and fundamentals there with your Seattle/Northern California versus Southern California here.

Go ahead, Tyler.

We, you know, we gave some statistics on the 445,000 square feet of LOIs. So the third quarter leasing on LOI statistics -- we'll provide that on next quarter's call but I think just as you said. If you look at our portfolio in the Bay Area and Seattle, there's not a lot of vacancies, so -- there's a little bit but not a lot, so you can imagine where most of the LOIs are based, but we'll provide the details of the 900,000 square feet on the next call.

Okay. In terms of the incremental G&A cost, just to clarify that this is all due to additional personnel, not existing personnel?

Well, no. In the second quarter it had nothing to do with new personnel really. It primarily related to public company costs that we have typically in the second quarter. You noticed that we were down a little bit in the first quarter and up a little bit in the second quarter, so on average it was about $7 million a quarter, $14 million for the half and we expect that run rate to continue, although that run rate will pop up a little bit from these additional hires on the personnel side. So I said $0.01 or so in the second half above the run rate of $14 million in the first half.

Okay. One last question in terms of your dispositions, obviously it appears that your dispositions that are being marketed right now are obviously to investors. Have you been broached by your current occupants in terms of large campuses that could kind of alleviate some of the marketing needs here?

Well, this is John. Let's just say that there's a number of -- we have tenants that want to buy and that have expressed interest in buying. We really don't want to get into the details of it, but with regard to the assets -- as the case in point the 3 that are out there, let's just say there's some talents that would like to buy those assets if we decided that we wanted to go to the market.

All right. Fair enough, thank you.

And your next question come from the line of Chris Caton from Morgan Stanley. Please proceed.

Hi. Good morning. Hey, John, I was hoping you could talk about your new Wateridge Circle asset in San Diego. Can you compare that to the rest of your portfolio in the area? Looks like it's a 1990s vintage product. Maybe your product there is about 10 years newer, so I wondered how the basis 185 compares to how you see the value of your existing properties.

Yes. That's an acquisition that -- let me back up a bit. I think that if we take a look at the great recession, as it's being called, and we take a look at how robust the disposition market was that proceeded that, I could go back and make a different decision, I would have sold more into that market, but, nobody knew it was going to crater just the way it did. Fortunately we weren't making acquisitions then, but by that comment I want to make sure that everybody understands that we're going to be more active in buying and selling within the limits of the rate rules.

This asset that you're speaking of is an asset that we bought with a great going in yield, with good tenant profile, with an opportunity --you can essentially double -- the FAR approves is essentially twice of what's there. We bought at a great price per pound. It is not something that I personally am in love with for long term ownership. So I think that's an asset that over time you were going see us be able to increase the value substantially and it will more than likely end up at some point being in the disposition portfolio.

Round numbers where's the net rent today for something like that product?

Well, the rent is well below -- that's one of the things we really liked about it -- is the rent is well below what we're seeing in market. And I think when we're able to talk about those LOIs that are getting converted to leases down in San Diego, the people are going to appreciate more where the rents are going, not that these are exactly the same assets. But Jeff, on that asset per square foot, the rent versus market?

Yes. The in-place rent versus market rent, it's at least 10% below market.

Thanks and then last question, Tyler, your guidance refers -- has acquisition costs added back. Is that right?

Well, we have $0.03 of acquisition costs in our numbers in the second half. So we don't add that back. We are deducting that from our numbers.

Thank you.

(Operator Instructions) And you have your next question from the line of Mitch Germain from JMP Securities. Please proceed.

Tyler, just a clarification on the $69 million of mortgage debt, you're paying that down? Is that the plan?

Yes. The plan is to pay it off.

And will that be done in late December or will you be doing that earlier?

I believe we have like a 60 or 90 day period where we can prepay it without a penalty and we'll pay it off as soon as that occurs. So I think it's early October.

Thank you very much.

You have a follow-up question from the line of Michael Knott. Please proceed.

Hey, guys, could you give maybe just a little bit more color on the renovation/contribution of the development site? I think you said lot -- that doesn't look like it shows up on your redevelopment pipeline page. Maybe just any 10 seconds of color on that project.

You're talking about lot 7?

Yes.

Tyler?

Yes. I think you're referring to the LOI that John mentioned which we're incorporating lot 7 into. What are you trying to get at?

I'm just trying to understand, so it's 1 tenant that's going take an existing building? It sounded like you're going to renovate that building as well and then, I guess, build something new for them on lot 7?

Yes. We're going to take the existing building, renovate it and incorporate the land piece into that campus to give them a new campus on about 100,000 square feet.

Any rough ballpark figure on total costs there?

You know, we're still in negotiation on that, so I again apologize, but I think we'd rather not comment at this point on the details.

Okay. Fair enough and then, Tyler, last question, in your guidance commentary you said there was a $0.03 negative impact from the last guidance from something. I didn't catch what that was, if you could remind me.

Yes. Just on the timing of the closings of the acquisitions. We have 4 pending acquisitions and when we provided guidance on the first quarter call, in our numbers we were assuming sort of July, August kind of closing and those slipped for various reasons, 1031s or debt assumptions. So we're now assuming more towards the beginning of fourth quarter I think on average. So that has pushed out the accretion that we're going to get from those deals when we buy them.

Okay. Thanks a lot.

And I show no more questions at this time. I would like to turn it back to Mr. Rose for closing remarks.

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

Ladies and gentlemen, that concludes today's presentation. Thank you for your participation. You may now disconnect. Have a great day.