Kilroy Realty Corp (KRC) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the third quarter 2011 Kilroy Realty earnings conference call. This call -- my name is Tanya and I will be your conference moderator for today. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to hand the presentation over to your host for today, Mr. Tyler Rose, CFO. Please proceed.

Good morning everyone and 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 that some of the information we will 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 8K with the SEC and both are also available on our website.

John with start the call with an overview of the quarter and look at our key markets. I will follow John with financial highlights and updated earnings guidance for 2011 then we will be happy to take your questions. John?

Thanks Tyler. Hello, everyone and thank you for joining us today. And thanks again to all of you who have participated in our Seattle Investor Day last month either in person or via the Internet. We appreciate your time and interest in KRC. For anyone who like more detailed review of our Seattle investor presentation, it is available on our website.

Today I will bring you up to speed on our activities since our last conference call. In summary, we have made significant progress on several fronts since the end of the second quarter and have set the stage for continued long-term growth through our strong leasing performance, well timed acquisitions, ongoing capital recycling program and the growth of our management capabilities both in the San Francisco and Seattle area markets. Our leasing momentum continued to accelerate with quarter end occupancy at 93%. And as we reported last night, we are very pleased to announce that we signed a long-term lease with DIRECTV for 720,000 square feet in our three-building El Segundo campus. We will provide more details on this transaction later in the call.

We completed our fourth acquisition in the SoMa District of San Francisco, further expanding our West Coast franchise and building our portfolio to 1.6 million square feet in one of the best markets in the country. And we have made significant progress in our capital recycling program. We completed a $24 million disposition in San Diego and now have four other properties in the market, two of which are in escrow. The four properties in the market are projected to generate proceeds of approximately $205 million mostly by the end of the year.

Let me go through each of these activities in more detail. Leasing activity continued to gain strength in our markets since the end of the second quarter. Including the DIRECTV lease, we have signed new and renewing leases on approximately 1.5 million square feet since the end of June and currently have an additional 400,000 square feet of in-place letters of intent. Year-to-date we have executed leases on 2.2 million square feet, putting us on track to achieve the best annual leasing performance in our history. As a result of our continued strong leasing, occupancy and our stabilized portfolio increased 640 basis points to 92.8% at the end of the third quarter, up from 86.4% a year ago. Turning to acquisitions, we remain disciplined buyers in a marketplace in which core real estate tends to be fully priced while value add properties tend to be discounted below their long-term potential. We are focused on these value add opportunities in the West Coast markets populated by knowledge-based tenants.

We continue to be ahead of the curve with regard to our acquisition activities, particularly in San Francisco where tech and media demand remains very strong. We were early in the cycle when we made our first purchase in SoMa in mid-2010. We had been looking at that market for some time studying the growth drivers and observing tenant expansion requirements. These observations have now led to the closing on our fourth acquisition in SoMa, 201 Third Street is a 312,000 square foot 12-story office building. Our timing we believe is ideal on this acquisition as we acquired the property in an off market transaction priced last February for just over $103 million, about $330 per square foot. The in-place rents on average are approximately 40% below market rents on a triple net basis. The current escrow, during escrow we moved the leasing status from 90% to 99% at a rate reflective of today's market.

Similar to our strategy at 303 2nd Street, we plan to significantly upgrade the common areas and to reposition the asset to meet the needs of the modern workforce. Our projected all in cost will be significantly below today's replacement cost. While the SoMa submarket is exhibiting significant increased tenant demand, higher rents and low vacancy, our four SoMa properties are now 97% leased. Given this high occupancy, we don't have much space available in the near-term to accommodate the numerous tenants currently looking for space, however, we have found a way to take advantage of the growing demand for tech and media space. We are announcing today that we have just gone into escrow to acquire a 402,000 square foot seven-story office property located at 370 Third Street in the heart of SoMa. The property has two Comcast Sports networks as the buildings only tenants occupying approximately 9%. The balance of the space, with further modification, is ideally suited to accommodate tech and media tenants. The acquisition price is $92 million or $228 per foot with closing estimated for December of this year. Our intent is to further reposition the building over the next several quarters to attract tech and media tenants that currently cannot find adequate space within this market. 370 Third is subject to a long-term ground lease through 2097 however, we intend to exercise our right to acquire the land in late 2012.

While we wouldn't be buying vacancy in many of our markets given the macro environment, we believe the leasing status of our existing assets coupled with the strength of the SoMa markets makes this acquisition a terrific opportunity to create significant shareholder value. Since entering into escrow, we have received multiple RFPs totaling almost one million square feet. Now let me give you an update on the remainder of our pending acquisitions which has changed a bit. While we are still under confidentiality agreements on these deals, I can provide the following information.

We expect to close next week on the acquisition of a $30 million brick and timber building in the SoMa District. The building is one of the highest quality brick and timber projects in the entire city of San Francisco and has been recently renovated. It is 65% occupied and during escrow we moved the leasing to 100% committed with in-place rent significantly below market and the existing 65% occupied. Next is a $75 million office property in one of the key entertainment markets of Los Angeles for which the purchase price was agreed to in early 2011. Given the complicated ownership structure of the seller's partnership, and the need to obtain approvals to assume $55 million of CMBS debt once the partnership issues are resolved, the timing of this deal has changed quite a bit. And at this point is likely to occur in the second quarter of next year. Finally, we have a fourth pending acquisition and San Diego, given loan assumption terms that are not acceptable to us, there is uncertainty whether this transaction will be completed.

Looking at the larger picture, our acquisitions over the past two years have expanded KRC's footprint into two major West Coast gateway cities, San Francisco and Seattle, positioning KRC as the premier West Coast landlord. The Bay Area and Seattle, two of the best performing markets in the nation, now make up more than 24% of our NOI on a pro forma basis excluding the impact of the to be acquired 370 Third Street building. As announced previously, we have increased our capital recycling program to help fund this expansion in the third quarter. We closed a $24 million R&D complex. We now are in escrow on two San Diego buildings for approximately $140 million. In addition we are in final negotiations to select a bidder on the disposition of an industrial property in Los Angeles.

Lastly, we have an Orange County land parcel in the market. Based on current bids these two properties are expected to generate proceeds in the $65 million range bringing estimated disposition proceeds to approximately $205 million above the $24 million already closed. Generally our disposition properties are those that have limited upside for us to increase value. We have focused on selling these types of properties to fund acquisitions in gateway knowledge markets where we can add additional value to generate higher returns.

Turning to our redevelopment pipeline that totals 508,000 square feet of office space, let me give you an update on our three projects. First, as I mentioned we just executed a lease with our long-standing tenant DIRECTV to provide them with a new headquarters campus at our three-building project in El Segundo formerly known as Kilroy Airport Center Los Angeles. The lease has a 15-year nine-month term, and over time total 720,000 square feet. DIRECTV currently leases approximately 333,000 square feet in two of the three buildings, 2240 and 2250 East Imperial Highway. The newly executed lease extends DIRECTV's existing lease expiration date for these two buildings from July 2014 to September 2027 and allows for the company to occupy over time via a must take provision, the remaining 89,000 square feet within the two buildings that are currently occupied by other tenants. DIRECTV will also lease the entire 299,000 square feet of the third building, 2260 East Imperial Highway, which is currently undergoing redevelopment through September 2027. Occupancy in this building is projected to occur in the fourth quarter of 2012.

Second, and as we had previously reported, we are redeveloping a 98,000 square foot office building within our Kilroy Airport Center Long Beach, half the building is leased for 11.5 years and the other half will come online over the next several quarters. The rent under the new lease is 52% higher than the rent paid under the prior lease. Our third redevelopment project is in the Sorrento Mesa submarket of San Diego. In the third quarter we signed a lease with TD Ameritrade for 7.5 years on a vacant 111,000 square foot office building in our Sorrento Gateway campus. We will be incorporating the adjacent Sorrento Gateway Lot 7 land into the campus for additional site amenities and future expansion. As we mentioned at our Investor Day, the lease provides us with a strong credit tenant at a rate that's 38% higher than the rent paid under the prior lease. We expect to complete renovations for an estimated occupancy in the third quarter of 2012. With these transactions, our roughly 508,000 square feet of current redevelopment properties are now 90% leased.

Now, let's review our individual submarkets. In summary, the strength of our submarkets vary. Some like San Francisco are performing quite well while others like Los Angeles are just now on the ascent. I will start in San Diego, a region that has experienced positive absorption every quarter for nearly two years. We're seeing increased momentum in Delmar and Sorrento Mesa and the technology corridors around those two markets. There's been a significant reduction in availability of large blocks of contiguous space in KRC San Diego submarkets. As an example, the vacancy rate for Class A space in the Sorrento Mesa submarket has dropped from 12% at the beginning of the year to 8% today. Demand is up and rents have recovered for quality product. Currently in Sorrento Mesa there's only one block of space available that is greater than 80,000 square feet, down from four earlier in the year.

Vacancy rates have fallen in most San Diego submarkets with rates in Delmar and Sorrento Mesa Class A office properties now in the single digits. Overall demand is diversified across several industries including technology, life science, finance and professional services. Our San Diego portfolio is 93% leased at the end of the quarter. Further north in Orange County the industrial market experienced over two million square feet of positive absorption in the past 12 months leading to a vacancy rate just under 5%, the lowest figure seen in 2.5 years. The Orange County office market experienced a fifth consecutive quarter of positive absorption totaling 2.6 million square feet, the longest trend of positive absorption since 2006. Overall, our Orange County portfolio was 99% leased at the end of the quarter, the office portfolio was 93% leased and the industrial portfolio was 100% leased.

Continuing north to the greater LA Metro area, demand remains uneven. Although the trend turned generally positive, the office market experienced positive absorption and overall vacancy rates declined modestly in the third quarter. In our West LA office market, demand and tenant activity continued to pick up with interest from a range of entertainment, tech and media firms. Net absorption was positive and rents were modestly up from last quarter. Our Santa Monica Media Center is now 100% leased and we have several LOIs for the Westside Media Center that would also bring it to 100% leased. Currently we are 93% leased in this submarket. The 101 Corridor market had modestly positive absorption in the third quarter. We are 96% leased in our Calabasas properties and 32% leased in our Ventura County properties given the second quarter lease expiration we discussed on our last call.

Moving to Northern California, San Francisco remains a stand out performer, the supply of available large contiguous blocks of office space in the SoMa submarket is the lowest it has been since 2000. Very strong demand in SoMa has boosted rents more than 50% on a triple net basis over the past 18 months. This demand is largely driven by technology and media tenants as well as the internet arms of leading retail firms. Our San Francisco portfolio now represents approximately 16% of our NOI on a pro forma basis and upon the acquisition and lease up of 370 Third Street would be approximately 18%. Overall, our San Francisco properties are 97% leased.

Moving on to greater Seattle which represents approximately 8% of our NOI on a pro forma basis. This region is among the national leaders in job growth and office space net absorption. Our East Side submarket experienced positive absorption for the sixth consecutive quarter, large technology and media companies account for a major portion of the leasing activity. With demand also coming from the advertising and business firms that support these companies. Our East Side portfolio now totals close to 900,000 square feet. These properties were 90% leased at the end of the quarter.

That's an update on our market conditions and activity. Recently the real estate brokerage firm of Jones Lang LaSalle published its inaugural high technology report that highlights some of these points, specifically, J.L.L. reported that four out of five of the submarkets where KRC has substantial holdings are considered amongst the country's top tech markets. We posted this report on our website for your review. As we approach the end of 2011, we view today's market as one that is challenging and uncertain, but also one in which there are opportunities to create value. We believe our platform is stronger today than at any time in the company's history. We have a superior management team with multi-cycle experience in the West Coast markets in which we operate and that are dominated by vibrant knowledge-based companies. We have a strong balance sheet with access to multiple sources of capital and we are positioned to take advantage of market dislocations to create significant long-term growth.

With that, I'll turn the call over to Tyler who will cover our financial results in more detail. Tyler?

Thanks, John. FFO was $0.56 per share in the third quarter. That includes $0.02 a share of acquisition related expenses. Also due to the weak equity markets, we reported a savings in G&A expense for the quarter of approximately $0.01 per share as the result of a mark-to-market adjustment related to the Company's deferred compensation plan. Under GAAP, if the value of the investments in the deferred comp plan goes down, there was a reduction in compensation expense for G&A. This reduction is offset by a reduction in investment income, which hits a different line item on the income statement, so net net there's no impact to FFO or net income.

Our stabilized occupancy rose to 92.8% at the end of the third quarter, up from 90.2% at the end of the second quarter and 86.4% a year ago. By product type, industrial occupancy increased 240 basis points to 100% at the end of the third quarter, up from 97.6% at the end of the second quarter. Office occupancy increased 270 basis points to 90.6%. As of today our properties are 93.8% leased.

Same-store NOI continued to improve adjusting for a 2010 one-time item related to the receipt of a legal settlement, cash and GAAP same-store NOI increased 8.4% and 4.3% respectively. Rents on office leases signed in the third quarter were up 1.4% on a GAAP basis and down 2.3% on a cash basis. For industrial leases GAAP rents were down 6.7% and cash rents were down 23.8%. Of the leases we signed since June about 75% were office. By region, rents on leases we signed in Los Angeles during the third quarter were essentially flat on a GAAP basis and down 6.2% on a cash basis. In Orange County, rents were down 6.6% on a GAAP basis and 19% on a cash basis. In San Francisco, rents were up 6.4% and 6.7% on a GAAP and cash basis respectively.

As of today, we have approximately 400,000 square feet of LOIs outstanding, approximately 90% of our office leases and 40% of our new leases. We estimate that rent levels in our overall portfolio are approximately 7% over market. We have no significant lease expirations remaining in 2011. Year-to-date, we've now acquired six office projects adding just under 1.5 million square feet to our stabilized portfolio. We paid an aggregate purchase price of approximately $516 million. On average, the stabilized cap rate was 6.7% and the estimated average IRR is approximately 9.1%. This compares favorably to recent comps in our West Coast market. Subsequent to the end of the quarter, we paid off a $69 million maturing mortgage that had an interest rate of 6.7% and a $52 million maturing mortgage that had an interest rate of 5.1%.

To sum up our capital requirements through the remainder of the year, assuming we complete the two pending SoMa acquisitions and complete the three asset sales scheduled for this year, and everything else stays the same, we would end the year with approximately $50 million drawn against our bank line. On last quarter's call we announced that we had established a $200 million ATM program as an additional tool to manage our balance sheet, to date we have not used the facility and it remains available.

Now let's discuss updated guidance for 2011. To begin, let me remind you that with all the uncertainties in today's economy, we approach our near-term performance forecasting with a high degree of caution. Our internal forecasting guidance reflect 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 -- Our projected year-end occupancy rent remains at 92% as the stabilized disposition properties are all 100% occupied. The DIRECTV and TD Ameritrade leases have no significant impact on 2011 numbers and while we're not providing 2012 guidance on this call, revenue recognition associated with these transactions is expected to begin in the second half of next year. In terms of our pending acquisitions, our guidance assumes the closing of $30 million in mid-November and $92 million in mid-December.

Termination of the San Diego acquisition has about a $0.01 negative impact on fourth quarter FFO compared to our prior guidance. We also estimate that fourth quarter acquisition related expenses will total about $0.02 a share including added costs associated with the 370 Third Street. Of the estimated $205 million of asset sales, we assume we will complete about $180 million in early December. Taking all this into consideration, we are providing updated 2011 FFO guidance that tightens our previous range of $2.22 to $2.29 per share to a new range of $2.22 to $2.24 per share. That's the latest news from KRC. Now, we'll be happy to take your questions. Operator?

(Operator Instructions)

Jamie Feldman, Bank of America Merrill Lynch. Please proceed.

Thank you. Tyler, I just want to make sure I heard you right. So you're saying based on all of the acquisitions and dispositions mentioned on the call, you would end the year with $50 million drawn on the revolver and then you would look to the ATM to raise more capital?

Not necessarily. We're looking at other dispositions as well. We have the ATM available; we haven't used it yet. As we've talked about, we plan to keep our leverage intact and do acquisitions on a leverage neutral basis but our strategy lately has been to capital recycle. So we will continue to look for new or other properties to dispose of.

So I guess what does the pipeline look beyond what you guys mentioned so far? In terms of acquisitions and in terms of kind of non-core assets?

I let John cover sort of the bigger picture, but as John mentioned in his remarks, there's the one Los Angeles acquisition which are now projecting for second quarter of next year, so that's the only definitive project sort of in the pipeline. But I will let John cover sort of the market.

Will yes, hi Jamie, we obviously look at a lot of things and reject most. And we stay agile to take advantage of opportunities that might come our way that we think are outstanding. But I really cannot add much more on the acquisition front than what Tyler has said. We have the ones that we've notified everybody on in the call this morning, but we are looking at others. We don't have any other paper going back and forth in a big way. We have a couple of redevelopment plays that we are keenly interested in, but more to come.

On the disposition front, we are analyzing our industrial portfolio. We've had quite a few people make us unsolicited offers on that and indicate interest, and as you know, that represents about 7% or 8% of the Company's NOI. It is 100% leased. So we're going to continue to look at how we prune our existing portfolio and convert stabilized deals into something that we can turn into higher yields over time.

Okay. And then you talked about a lot of leasing in SoMa, can you talk a little bit more about the types of tenants and the credit of those tenants? And just kind of how solid the cash flow is at this point?

Right. Well in San Francisco in the tech right now, and I know you were at our Seattle conference and we covered some of this, but last year was sort of the high watermark of tech leasing in San Francisco with just under 1.2 million square feet through the third quarter, there was about 1.1 million square feet of leasing done in the tech area, most of it in SoMa. There's another 2.7 million square feet in that market today with the lion's share circling SoMa. There are all kinds of folks with different credit, but the tenants that we are looking at, most of them have very, very good credit and we are very keen on making sure that we focus on those kinds of companies. So we're not really interested in doing a sizable transaction with anybody that doesn't have a balance sheet.

Okay. And then finally, as you look at your lease expirations for 2012, where do think the mark-to-market is on those leases?

We are about 10% over market on those leases.

Okay. All right, thank you.

Michael Bilerman, Citi. Please proceed.

Hi, thanks, it is Josh Attie, with Michael. Could you talk about your lend bank and any opportunities you might have to monetize that next year and into 2013, particularly some of the larger pieces that you have in San Diego?

We have a lot of things going on down there. A combination -- as we've spoken about before, we are constantly looking at how we re-entitle or expand our entitlements, we're going through that on a number of properties right now. The most noticeable one is One Paseo, where we are making very good progress on the mixed-use concept. We've had a number of unsolicited -- really haven't been dollar offers, but dollar ranges from folks that would like to capture the roughly 600 residential units in there. Mostly apartments and some condo. We have folks that want to do the retail and so we are going to figure out once we -- our EIR will be out here shortly, we will figure out who we are going to do business with on some of the other non-office components in due course I think that's probably at least a few quarters away although we are having discussions with folks at very good numbers.

With regard to the other parcels, we have interest from folks in regards to the potential development for them of largely pre-leased space. We are taking a look at Lot 2 in Sorrento Mesa for an 80,000-foot building, as I made comment to in my remarks, there's only one building that's 80,000 feet that's available in that market, in a Class A, it's 20 years old, it's well located, but it is not very modern. And we think that Lot 2 could be put into play here sometime this next year. More to come.

On Santa Fe summit where we have Phase II and Phase III, we have interest from some folks in one of those phases so we are hopeful we will be able to do something. But again, I can tell you we've been asked many times, have we seen the macro environment hurt us or have we seen deals back out? We haven't on the leasing front in the portfolios -- in our core portfolio and in the stuff we are acquiring. Where I think it does arrest people in their decision-making is, to some degree, is on the development stuff because people are looking at projects that would be developed two or three years out and people are concerned about where things are going to be at the macro level. So I think macro level does hurt us on the development side for sure. That's a recap of where we are at. We're making good progress, I think, in our discussions; we need to get some of those through the hoop.

Thanks, that's very helpful. If I could ask one more question, could you talk about the dividend coverage and with the added redevelopment project that you are doing for DIRECTV, does that push out further when you think you'll be covering the dividend with free cash flow?

Yes, I think we've talked in the past about the fourth quarter of this year was when we would start to cover, and with the DIRECTV deal and the leasing commissions they'll be paying we will probably -- some of the timing of that still isn't quite defined yet, but the fourth quarter will be close, but we may not cover in the fourth quarter. Going into next year, it's really dependent on the TI spending on the DIRECTV transaction. So I think overall, we are hopeful that -- excluding DIRECTV we should be covering next year and then it just depends on the timing of the DIRECTV expenditures.

Okay, thank you very much.

Chris Caton, Morgan Stanley. Please proceed.

Good morning. John, could you talk a little bit about the leasing in SoMa? At your Investor Day you talked about how the requirements in the market exceed the available space, where do you see that demand flowing? And then specific question with Twitter, relocating the Civic Center submarket, do see that being the next kind of natural valve and are you at all worried about development in the SoMa area?

Let's deal with the development first. In order to develop you're going to be in there well in excess of $100 a land square foot, probably closer to $200. You are going to have at least a $600 price tag and probably higher, and you are going to have some period of time within which to get a building up and all the rest. So I think it is going to be expensive to develop. Our play has been to take buildings that have the physicality, first of all, that have the sweet location and like anyplace else they're sort of Main and Main, and then as you move out from that, space tends to be less desirable, although in a robust demand market like this, people are having to go a little bit out of their -- out of where they'd ideally like to be in order to find space.

The thing that we look at is beyond the location, the physicality of the building, and by that I mean the ability to track and retain the technology and media tenants that like the collaborative office space. It means they've got to have the right height between floors, the right kind of light, the right kind of layout, obviously, they are very dense operations. Some of these are as much as 105 feet per person. Think of the old traditional 300 square feet per person. And it is one of the reasons they want to be near the rapid transit, because in San Francisco it is very hard to find buildings with parking and when you do, it is a low ratio, so people are arriving by rapid transit. And once you get further afield from SoMa and you go out towards Twitter, you really have a problem in the people mover systems and so forth that deliver your folks to and from work.

In terms of the Twitter location itself, hats off to Shorenstein for doing that deal and I'm sure they are going to love it out there because they are moving out there. I think you'll see other people go there in due course. It is a little bit rougher area. It does not have the amenities. It does not have the transportation that the areas within SoMa that we have. And I think those are deficiencies, quite frankly. Did you want to say something, Eli?

Yes, I would just add one thing to Twitter moving out there and everybody has to remember at the time that Twitter made that decision, that was an economic advantage zone where they were allowed to get an exclusion from the city excise tax on options that were issued to IPO companies. After Twitter made their commitment to go out there, the city widened that exemption to citywide, so it was initially a financial incentive for them to go out there and I suppose if we were doing it today, one could conjecture that they might not have been as excited as going out there. And I think the way the tax works right now, there's much less pressure and demand to go out there compared to the close-in SoMa markets. I think what's ultimately going to push people out of the close-in SoMa markets is going to be tightness in pricing, more so than what happened initially with Twitter, which was a financial incentive that no longer exists.

And Eli, is the Twitter space that they are vacating, which I think is basically adjacent to the Convention Center, is that going to be immediately competitive when they move out?

Yes, it's nice. It is only about 80,000 feet. It is a decent location. It is about as far west as I would want to be. It is fine. I mean, it is certainly competitive space, it is just not a lot of it.

Thanks, and then just last question for John, and we talk about information or media, can you talk about that in San Diego? Are you repositioning any of your assets to target that type of demand profile? I think you don't talk about it as much in San Diego, but also you do have a fair amount of users like that down there?

San Diego has historically been highly technologically populated, whether it is life science or whether it is electronics or whether it is the Qualcomm and the many telephone providers, so I guess I assume, maybe incorrectly, that there is a greater understanding that they are a technology powerhouse -- meaning San Diego. So I tend to talk about tech and media more in San Francisco, Seattle, of course we've always talked about it in West LA, simply because that is where the real demand is, it is not in the traditional CBD office space. That's not where you see the bulk of demand in San Francisco. Whereas, in San Diego, it is a technology neighborhood.

And if you take a look at the tenants that we've historically done business with down there, the Qualcomm's and Ericsson's of the world, the Intuits, now TD Ameritrade, LPL, these are all technology-based companies and it might be the technology component of a financial company. Might be the technology component of some other kind of operation, but San Diego is that way. So our buildings historically have been designed to attract those sorts of users and we constantly are upgrading our buildings and whatnot throughout our portfolio, certainly in San Diego, to make sure that they have the latest and greatest, the bandwidth and all those things that these types of users need. We've always been long on parking in our developments and amenity rich so those tend to be good for any particular type of user.

Thanks.

You're welcome.

Mitch Germain, JMP Securities. Please proceed.

Good afternoon. John, just curious with Orange County, your thoughts there as you are approaching selling assets, I know you sold a land parcel there now, but would you look to pursue any outright sales of assets there?

Yes, we would. We are in the process of selling that land parcel. I don't know whether we've had best in final yet, but we are nearing the end of the auction process, that's right, and we'd expect that asset to close by the end of the year, is that right?

Yes.

With regard to other assets, when I talk about looking at industrial, whether we would sell all or a portion of the industrial, the lion's share of our industrial is in Orange County. The only industrial building we have outside of Orange County is in LA County, and that's one of the buildings that we are in the process of picking a finalist for right now. So if we sell industrial, by definition it will be Orange County. We've got a few little odds and ends on office that we are repositioning down in the Irvine Spectrum. In due course, those buildings may be spun out as well. We don't view those as strategic.

Great and just if I could get some -- the activity on your 4 vacant assets, please?

Okay, I'm sorry, I don't have that, but Jeff or Michelle, the 4 vacant assets are, what?

Well, just leasing activity that you see.

I just got to think, I don't think in terms of which building is totally vacant, I think in -- I don't -- I'm not looking at --

It's 9445 Town and Country, it is Ventura County.

Town & Country, okay, let's take San Diego first. We have a number of people that are interested in that and that also, by the way, is a parcel that -- or is a building that we look at potentially having a much higher, better use. We are working right now to get that zoned for I think it is 150,000 or thereabouts square foot medical office building. We have a number of people that need that kind of space in that market, so we will probably do a short-term lease and reposition that site. Then moving up to what are the addresses?

The smaller building.

The 60,000 footer, next to the building that TD Ameritrade has, we have interest in that building right now. And we hope to conclude a transaction, then we have--

On the I-15.

The I-15 Kilroy, or rather, Sabre Springs Corporate Center. We have a proposal that is going back and forth for the entirety of that project. Then for the other building that's vacant, it would be out in Ventura, out in Camarillo, and we are working to reposition that building, that market is soft. It is a relatively small asset in terms of revenue. But nevertheless, it's one we want to get leased and Jeff, anything more to report on that one?

No. I think you've covered it. We've got tours and we are looking at how to reposition that asset, but it is about 50% occupied currently.

Anything else?

Thank you.

You're welcome.

John Guinee, Stifel. Please proceed.

Hi guys. This is more of a curiosity question, Eli. If you look at your 370 Third Avenue, a little bit unusual, 55,000 - 60,000 square foot floor plates, ground lease, et cetera. When you roll it up to stabilized and you've expended all the TIs, leasing commission, acquired the ground, OpEx carry, et cetera, what's your per foot stabilized on that?

It depends on how aggressive we ultimately reposition it. I would say the range is in the range from, call it, maybe 385 on the low end to 415 on the high end. We have some more grandiose plans that, if we can fit them into the execution schedule and get them done, we think would be transformative for the asset. And obviously we want to get the highest return on capital, and there's a lot we are working. It is very intricate, we have to look at multiple moving schedules at the same time; the schedule of when the demand is currently occurring in the market and when they need to be in there. But timing at which we can get the kind of improvements that we ultimately want to get done that we think will raise the rents in the buildings, make it more attractive from the outside as well as inside, materially more attractive from both of those locations.

And lastly, kind of lining up those two pieces with any competition that we see coming down the road to basically weave the most profitable path for that asset, because there is strong demand now, we can capitalize on that. Can we capitalize on that and do all of the things that we hope to do with respect to the rehab? That's something to be determined. And can we beat the projects that might come online down the road to the market and lease up before then, that would be our objective. We think that's potentially accomplishable right now, but we are working on it. So, to simply answer your question, the lower kind of reimprovement plan would be in the, call it, high 300s and maybe a more robust one would be in the low 400s, including purchasing the land, carry everything that you talked about, they're all-in, fully leased up 100% basis.

Okay, and then --

John, this is John Kilroy, you mentioned the larger floor plates. The larger floor plates are one of the things that attracted us most to the building because those are exactly the kind of floor plates the big users want. Big floor plates -- if you think of our 303 Second Street project where we have some big floor plates -- those are the areas, the current areas that are in highest demand right now.

Okay. Good. Thank you and then Tyler, one question for you. When you look at all your sources and uses and what you expect to get done by the end of the year, have you de-levered or levered year-end '11 or year-end 2010 to year-end 2011?

Our leverage -- well, I guess it depends on how you look at leverage, but certainly on debt-to-market cap rate, leverage has increased slightly and partly because of our stock price, but also we did issue equity earlier in the year and we're planning to sell some assets so it's close to being flat but it is a slight increase in leverage.

Okay, thank you.

Our goal is to be neutral over time.

Perfect. Thank you.

Michael Knott, Green Street Advisors. Please proceed.

Hello, just a follow up on John's question a little bit about the SoMa acquisition. What kind of stabilized yield are you targeting on that, call it, 400-a-foot basis?

I think it is going to prove to be conservative based upon the negotiations we're having right now with regard to that building and the rents that we think we are going to capture. Eli?

I think we are looking at over 8 and there's some variability in that, again, because of the scenarios. One of our scenarios potentially involves significant work on the exterior, which we think will change the image of the building in a fantastic way and will also garner higher rents. But I think the range is the low-8s to the mid-8s, stabilized based on what we're looking at as realistic market rents and lease up timings and carry, and all of that as it goes.

Okay, thanks. Then can you just talk about, maybe, the investment environment and south of Market, obviously, it is a more attractive market now, I think, in many ways than when you first got in there. Maybe you can just talk about how much more competitive it is or not, because some of this is value add. I'd just be curious on your thoughts and cannot help but observe that this building, if you're in at 400 a foot would probably be about what your 100 First cost basis was, right? And that's probably a superior location and building and obviously values have increased over the past year. Just curious of your thoughts on that broad topic.

Well, in regards to pricing, clearly there are more people combing the neighborhood for opportunities. We, fortunately, have had a pretty good hand because people know we perform. And we've been -- we know the lay of the land there I think, as well if not better, than anybody else. I realize it is a big statement for some -- for a company that didn't own anything in San Francisco two years ago, but we've really, I think, put together the right team and have the right position. With regards to valuation, we've seen some things trade at values we thought were too high, although they might be lower than some of the prices we've paid on some of our buildings and it is because the physicality of them. If they don't have the features that really permit you to have a terrific investment over time and obtain the kinds of returns we want to retain, the fact that they might be cheaper on a price per square foot basis, doesn't mean they are attractive to us.

On the other hand, there is a project that is under redevelopment, I don't know if they received their financing yet, it is just essentially adjacent our 201 Third Street, which is called 680 Folsom, and that's a building that's being stripped down, has been stripped down just basically to its concrete floors and columns and then it is being expanded and re-clad and really will be a top-notch Class A terrific building. Right next door, I would imagine their cost basis is going to be well north of 500. There's a building that they saw an opportunity to go in and buy an existing property and reposition it. In terms of overall values, cap rates have come down significantly in the market. We think that we've made money on everything we've bought. If you consider that 303 and 100 First and 201 Third and so forth, where we are looking at either high single or, probably now more in the double-digit projected IRRs, stabilized assets are trading in the 6.5% to 7% IRRs or lower, so values have definitely moved up in the market, Michael. There just isn't a lot of data on completed buildings that have been sold in the overall market, but I think that values have gone up. Do you want to add anything to that?

I think if you take a look at the building 301 Brannan, which we are closing on November 10 that John talked about in his script, we bought that, it was 65% leased, once we were on non-refundable we controlled the leasing of that and it was effectively something that we were operating and we leased that from 65% to 100%. And when those leases kick in and that building comes online with those new leases now, that will come on at an 8.2% yield. Which was very favorable. And if you look at the leasing parameters in the last yield that was done, the leasing income from that deal, divided by the cost basis of the building it is a 9% yield, so current leasing rates kind of reflect a 9% in that building on actual market conditions today.

So with respect to getting more deals in the market, I think it is going to be tough but not impossible. I would've thought the deal we did at 370 Third might have been impossible for us. What happened, though, is that the deal broke a couple of times and we were able to come in and they wanted somebody, so we were at a lower price than it was really trading at ultimately in market and we got it at a discount. Plus, we have the team on the ground of all the people who are just fully in the flow on the market, where we feel like we understood the impending demand and were able to respond to that and optimize that as well. It's very expensive there though, now. And any of the buildings, 201, 301 Brannan, that if they were traded in today's market they would trade a lot more than what we were -- than what we originally paid for them.

Okay, thanks for that commentary. Then my last question is just on your $50 million El Segundo redevelopment that you just signed a lease with DIRECTV. Do you have any comment on maybe how your un-levered yield shaped up there on that incremental investment, or maybe how the lease compared to your underwriting when you decided to redevelop?

Yes, we're ahead of pro forma clearly on that deal. It is a terrific deal for us. On the return on cost is roughly in the 10% range on the incremental investment, which was about $49 million or so.

Thank you.

Dave Rodgers, RBC Capital Markets. Please proceed.

I guess just a follow up on that same comment, just the broader redevelopment pipeline, with the other two assets in there as well. Could you comment on the redevelopment yields on either incremental or the all-in basis of those assets?

Yes, the range is sort of from 8.5% to 10% I think on the various projects on an incremental basis. It is all in that range.

Just to add a little color to that, the building that's down in the TD Ameritrade deal -- the rental rate on that is back to essentially the high watermark in Sorrento Mesa. It is in the mid -- it is between $2 and $3 a square foot, right in the middle there. With bumps, that ended up being about 8.75% yield, projected IRR of, in the strong double digits and an incremental project ROC of just near 20%.

The total estimated investment cost there include the TIs and LCs associated with the leases?

Yes, it includes our base -- this includes everything. On the incremental it is just everything, all new costs.

Okay, thank you for that. Then, John, broadly, you've talked about the demand for stabilized core assets out there and your interest in selling some of those. How do you balance that, I guess, against what your credit tenants situation that you have in selling some of these assets, as well as the exposure you've talked about, I think repeatedly on the call, being in these tech corridors, what should we consider to be the overriding force? Is it portfolio positioning or really just the ability for value add in the near-term?

All of the above.

All right, thanks.

You're welcome.

We have no additional questions at this time. I would now like to hand the conference back over to Tyler Rose for closing remarks.

Thank you for interest in KRC.

Thank you for attending today's conference. This concludes the presentation. You may now disconnect and have a great day.