Kilroy Realty Corp (KRC) 2011 Q4 法說會逐字稿

Good day, ladies and gentlemen and welcome to the fourth-quarter 2011 Kilroy Realty Corporation earnings conference call. My name is Tewanda, and I will be your coordinator for today. At this time, all participants are in listen-only mode. Later, we will facilitate a question and answer session.

(Operator Instructions)

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Mr. Tyler Rose, CFO. Please proceed.

Good morning, everyone. Thank you for joining us. On the call today with me 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 seven days, both by phone and over the Internet. Our press release and supplemental package have been filed on a Form 8-K with the SEC and both are also available on our website. John will start the call with an overview of the quarter and a look at our key markets. I will follow with financial highlights and initial earnings guidance for 2012. Then, we will be happy to take your questions, John?

Thanks Tyler. Hello, everyone, thank you for joining us today. The fourth quarter was another very active and productive period for KRC, capping what has turned out to be one of the Company's strongest and most successful years since our IPO 15 years ago. Throughout the year, we made significant progress in leasing, in the expansion of our franchise in the best West Coast markets and bolstering our management team, and in our capital recycling program.

The results are evident in our rising occupancy numbers and improving financial results, in the list of dynamic companies choosing to join KRC's tenant list, in the changing profile and long-term growth potential of our own enterprise. We are highly focused and motivated, we're executing well and we're building momentum in every market we serve.

Our fourth quarter leasing efforts produced new or renewing leases on 1.3 million square feet of space in 48 transactions. That pushed us close to 2.6 million square feet of leasing for the year, our strongest annual leasing performance in the Company's history. The nature of many of these leases also says a lot about our growing stature in the market as a landlord who can deliver flexible, creative workspaces, as well as global corporate headquarters to meet the unique needs of individual tenants.

And transactions like those with DIRECTV, TD Ameritrade, and Pac-12 Enterprises, to name just three, we are developing physical work environments in close collaboration with our tenants designed to advance their own creativity and productivity. Tenants such as these don't view their new work spaces as just real estate but as a strategic advantage in their businesses.

That kind of commitment tends to make strong partnerships and long-term tenants. Our expansion into important West Coast gateway markets also continued in the quarter. We completed the acquisition of two more properties in the SoMa district of San Francisco, the strongest real estate office market in the country with the reported Class A vacancy rate in the very low single digits. We've expanded our portfolio there to six properties totaling more than 2.1 million square feet. We've now become the largest Class A landlord in arguably the best real estate market in the country today.

I think there's a larger story going on here. Over the past 24 months, through careful acquisitions, geographic expansion, and talent recruitment, we have transformed KRC into the premier landlord along the entire West Coast. We now have a deeper bench of experienced management talent that has the full spectrum of capabilities across all regions and a growing real estate footprint in high potential Seattle and San Francisco markets to complement and diversify our strong position and valuable development pipeline in our traditional California coastal markets.

We have assembled all the elements for a much broader operating platform that can deliver significant additional growth in value creation for our shareholders. Our financial and operating results, despite a challenging market environment, have begun to reflect this reality. Over the past two years, we have executed more than 4.5 million square feet of leasing transactions. We have increased our occupancy 960 basis points and are now approaching our long-term average of 94%.

We have produced six consecutive quarters of rising cash same-store net operating income. We have acquired $1.3 billion of high-quality properties in key gateway markets at significant discounts to replacement cost. We have completed $228 million of dispositions as part of our capital recycling program. And, we've generated a strong total return for our shareholders. Looking forward into 2012, economic conditions remain choppy and rental rates are recovering unevenly. But county employment numbers have improved and our mark to market on existing leases is strengthening.

We continue to pursue acquisitions in the best West Coast markets with energy and discipline. We are seeing a fair amount of product come to market, both core and redevelopment transactions. And, we remain interested but prudent buyers. As previously announced in December, we completed the $92 million acquisition of 370 Third Street, a 410,000 square foot office property in the heart of SoMa, at a discount to replacement cost of approximately 35%.

The property was 9% leased and occupied at the time we entered escrow in the fourth quarter. And, during escrow, we increased the lease percentage to 37% signing an 11-year, multi-floor lease, with the Pac-12 conference's media subsidiary, Pac-12 Enterprises. We are in active negotiations on the balance of the space in the building. Also, as reported previously, we have a 320,000 square foot Los Angeles area office building in our pipeline that we expect to close in the second quarter for approximately $77 million, or $241 per square foot.

We estimate the acquisition price to be approximately 50% of replacement cost. It is a true value-add play as the current owner has limited resources to attract and retain tenants. It is currently 88% leased with in-place rents estimated to be approximately 33% below current market rents on a triple-net equivalent basis.

In addition, we are in active negotiations on a handful of other opportunities, primarily in the Bay Area and Seattle. Capital recycling will continue to play an important role in our strategic plans.

We completed the disposition of a 192,000 square-foot industrial building in the fourth quarter for a gross price of $45 million, or $235 per square foot, and recorded a net gain of approximately $39 million on the transaction. And, just yesterday we closed a $146 million disposition of two of our four San Diego medical office properties.

The purchase prices on the buildings translate to a price per square foot of $729 on the 151,000 square-foot building, and $350 per square foot on the 103,000 square-foot building, which implies strong valuation, we believe, for our San Diego portfolio.

I should note on the building that we sold for $350 a foot, the tenant did all the TI work at their expense when that transaction went together. The gain on the transaction was over $73 million.

Our capital recycling program has generated approximately $212 million since the third quarter of last year, and we currently have an Orange County land site in the market for approximately $25 million. Our strategy is to harvest the value of select assets and reinvest the proceeds in properties where we see better value-generating opportunities.

In a related initiative, we are currently evaluating several strategies for monetizing the value of our 3.4 million square-foot industrial portfolio, including a direct sale or a potential venture. New development also remains a possibility for 2012 given the combination of increased demand and the lack of available large blocks of suitable space in certain markets. Demand continues to grow in specific San Diego markets, particularly Sorrento Mesa, where the direct vacancy rate for Class A properties is below 2.4%.

Large tenants are once again beginning to seek new, high-quality space that may provide us with the opportunity to develop a new state-of-the-art property on land within our development pipeline. These same dynamics are also becoming more prevalent in certain Bay Area markets as well.

Given all these activities, we are enthused about our expanded management team. As a brief review, one year ago we added Eli Khouri as Executive Vice President and Chief Investment Officer. Also, in 2011 we added Mike Sanford, as head of our northern California Region, and Mike Shields as head of our Seattle Region. We also added to our Construction and Asset Management teams.

Finally, in the next few weeks, we will be announcing the addition of a new senior level hire who will be responsible for implementing our Los Angeles growth initiatives. In summary, as we look to 2012 it promises to be every bit as active and productive as last year. And we believe we have positioned the Company for both near-term and long-term growth.

Now, let's take a closer look at our individual sub-markets. All of our sub-markets are showing improvement, but at varying rates. San Francisco remains the top performer with Seattle and San Diego a close second and third. Los Angeles is improving slowly with wide variation among sub-markets. And Orange County is recovering faster than many anticipated. Starting in San Diego, the overall region has now experienced positive absorption for nine consecutive quarters and has its lowest unemployment rate in two years. There is increasing momentum in Del Mar and Sorrento Mesa in the technology corridors around these two markets with a significant reduction in availability of large contiguous blocks of space.

In addition, we are making progress at our Mission City property where we are working on leases that could take that occupancy to over 90%. Overall, San Diego demand is diversified across several industries including technology, life science, finance, professional services, and healthcare. Our San Diego portfolio was 92.5% leased at the end of the quarter. Moving north to Orange County, the industrial market absorbed over 2 million square feet of space in the past 12 months and the vacancy rate remains flat at 5%, the lowest figure in over 2.5 years.

The Orange County office market experienced its sixth consecutive quarter of positive absorption marking the longest stretch of positive net absorption since 2006. Demand was largely driven by the information technology, healthcare, and alternative energy industries. Also, after several quarters of declining rents, rates increased slightly in the quarter. Overall, our Orange County portfolio was 99% leased at the end of the quarter. The office portfolio was 95% leased and the industrial portfolio was 100% leased and occupied.

Continuing North to the greater LA Metro area, demand remains uneven although the trend turned generally positive. The office market experienced positive absorption driven primarily by a few large deals, including our recent 720,000 square foot lease with DIRECTV.

Vacancy rates declined modestly in the fourth quarter. In our West Los Angeles market, demand and tenant activity continued to pick up with interest from a range of entertainment, media, tech, consumer product, and service firms. Net absorption was modestly positive and rents were up slightly from last quarter. Our Santa Monica media center is now 100% leased with the recent expansion of Universal Music, and at our Westside media center we signed several leases last quarter that moved its lease percentage to 99%. Currently we are 98% leased in our West LA sub-market.

The 101 corridor Class A market had modestly positive absorption in the fourth quarter. We are 88% leased in our Calabasas properties, 91% leased in our Thousand Oaks property, and 15% leased in our 265,000 square foot complex at Camarillo.

Moving to northern California, San Francisco remains a standout performer with 2011 ending the year with nearly 2 million square feet of net office absorption. Of that, 500,000 square feet was in the SoMa sub-market. I should point out that doesn't include substantial leasing that's occurred on buildings such as 370 and another that's under redevelopment.

The supply of available large contiguous blocks of office space in SoMa is the lowest it has been since 2000 with vacancy in the low single digits. Very strong demand in SoMa has boosted rents more than 50% on a triple-net basis over the past 18 months. Demand is largely driven by technology and media tenants, service and support firms, and online retailers.

Looking at our other northern California -- looking at other northern California markets that are performing well, Sunnyvale, Menlo Park, Cupertino, Palo Alto, Mountain View, and Santa Clara all are basically at frictional vacancy. Our San Francisco Bay Area portfolio now represents approximately 18% of our pro-forma annualized NOI. Overall, our stabilized San Francisco properties are 96% leased.

Moving to Seattle, an area that now produces approximately 8% of our pro-forma annualized NOI. Our Eastside sub-market experienced positive absorption for the seventh consecutive quarter. Another strong sub-market in this region is the South Lake Union area, which now has a vacancy rate of 8%. Large technology and media companies account for a major portion of leasing activity in greater Seattle with demand also coming from the advertising and business firms that support these companies. Our Eastside portfolio totals 900,000 square feet and these properties were 90% leased at the end of the quarter.

That's an update on our markets, the market conditions, and activities. A quick recap, while market volatility and economic uncertainty are likely to remain, we continue to make great leasing progress and are seeing rental rates in some of our markets increase. We will continue to be disciplined acquirers in the best West Coast markets. This might be the year that KRC returns to development in select markets.

We will continue to execute our capital recycling program and consider other strategies for monetizing mature assets in our portfolio. We've expanded our management team to take advantage of what we believe will be increased opportunities throughout our various markets. And finally, financial strength and a strong balance sheet remain essential components of our operating strategy.

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

Thanks, John. FFO was $0.66 per share in the fourth quarter, and $2.29 for the year. That includes $0.06 a share in other income that resulted from a cash payment awarded through the bankruptcy court related to a 2009 tenant default. The fourth quarter also includes about $0.01 a share in broken deal costs.

We ended the year with stabilized occupancy at 92.4%, that's up from 89.4% at year-end 2010. Occupancy was impacted by the acquisition of 301 Brannan that is 66% occupied, the disposition of the LA industrial property that was 100% occupied, and by moving the two San Diego buildings sold in January, both 100% occupied, out of the stabilized portfolio. By product type, our industrial portfolio occupancy was 100% at the end of the fourth quarter up from 94% a year ago.

Office occupancy was 90% up from 88% a year ago. As of today, our operating portfolio is 94% leased. Same-store NOI continued to improve. GAAP NOI rose 10.1% and cash NOI rose 16.3% in the fourth quarter. For the year, GAAP and cash NOI increased 5.7% and 8.2%, respectively. Excluding the tenant default payment, fourth quarter GAAP and cash NOI were up 2.2% and 7.4%, respectively. And, for the full year were up 3.6% and 5.9%, respectively.

We added a new page to our supplemental this quarter that provides details on the leases that were signed during the quarter. We now provide detailed statistics for leases commenced and leases signed. As of today, we have approximately 330,000 square feet of LOIs outstanding, all of which are for office leases and 50% are for new leases. We estimate that rent levels in our overall portfolio are approximately 7% over market, down from 10% a year ago.

We have approximately 1.1 million square feet of leases expiring in 2012 which we estimate have rent levels about 10% over market. As previously reported during the fourth quarter, we completed the acquisition of two office properties in the South of Market districts of San Francisco.

In November we completed the acquisition of 301 Brannan Street, a 74,000 square foot brick and timber building, for $30 million. It was 66% occupied at the time of our purchase and we've now leased the remainder of the building. Full occupancy is expected to occur in April. The stabilized cap rate is expected to be 7.4%

As John mentioned, we completed the acquisition of 370 Third Street in December and it is now in our redevelopment portfolio. Pac-12 Enterprises is projected to take occupancy in mid-summer. The stabilized cap rate on the redevelopment is projected to be approximately 7.9%.

In terms of or dispositions, we completed approximately $212 million since mid-2011. The cap rate on the industrial transaction was 6.4% with in-place rents about 35% above market. Cap rate on the San Diego disposition was approximately 5.4%.

In conjunction with our recent disposition, our current bank line balance is now $120 million and our cash balance is roughly $40 million. During the fourth quarter, we raised approximately $13 million under our ATM program at an average price of $36.09 net of selling commissions.

Now, let's discuss our initial guidance for 2011 -- or, excuse me, 2012. To begin, let me remind you that we continue to approach our near-term performance forecasting with a high degree of caution given all the uncertainties in today's economy. Our internal forecasting and 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. In terms of acquisitions, we assume a closing on the previously discussed Los Angeles acquisition in the second quarter. The property's estimated purchase price is $77 million and, as part of the transaction, we will be assuming approximately $55 million of debt. We've only included $0.01 of acquisition-related expenses in our 2012 numbers at this point. We do not assume any further acquisitions or dispositions in our budget, nor any additional acquisition-related expenses.

We have assumed no ground up development starts in 2012. Average operating margins are approximately 70%. There's some seasonality in this number given the slightly higher utility costs during the summer months. We have approximately $250 million in maturities in the second and third quarter. We are currently working on a term -- bank term loan to refinance the maturing convertible notes and a secured loan to refinance a maturing mortgage.

In terms of G&A, as we discussed last year, our run rate has moved up a bit as we have added some very strong senior executive and regional talent to build out the management team for future growth. The big picture, our core G&A has been flat or down three years in a row. And, our G&A, as a percentage of revenues, has been falling as well.

For 2012, we are currently working on two initiatives. First, as we had discussed previously, the Company hasn't had a long-term incentive plan for several years. Given our strong performance over the last two years, we are now in the process of working with our compensation consultants to establish a pay-for-performance incentive stock option plan. We expect to issue ten-year stock options that would vest over five years to about 20 members of the KRC team.

Second, the Board is also working on restructuring employment contracts to restructure certain provisions that were market at the time of our IPO. In exchange, it is anticipated that there will be long-term restricted stock grants that would be earned based on a combination of shareholder return and time. While these agreements are still to be finalized, we have included an estimated accounting cost in our guidance.

Expense is almost all non-cash. Vesting will be over multi-year periods and achievement will be primarily based on stock performance at a time when our shares are close to a 52-week high. Our G&A run rate, which had been about $7.5 million per quarter, will now be about $8.5 million per quarter.

Moving to redevelopment, revenue recognition on 2260 El Segundo, part of the DIRECTV campus, is currently projected to begin by the end of the fourth quarter. Revenue recognition on 5010 Wateridge, or the TD Ameritrade campus, is currently projected to begin in late third quarter. We expect to end the year at 93% occupancy, subject to potential future acquisitions and dispositions. Taking all this into consideration, we are providing initial 2012 FFO guidance of $2.38 to $2.58 per share.

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

Thank you.

(Operator instructions).

Michael Bilerman, Citi.

Hi, it's Josh Attie with Michael. Just a quick question on the new stock plan. You said it was going to be performance-based. Is it absolute stock price performance or relative stock price performance?

I mentioned a stock option plan, so that's strictly performance of the stock. If the stock doesn't go up there's no payment. I also mentioned that there be potential restricted stock grants related to the restructuring of the employment contracts. And, that would -- it's still to be determined, but would be based on both a relative and an absolute basis as well as time. But, that's to be worked out.

Okay. How do you think about the dividend longer term? The coverage is pretty low today. But, your balance sheet leverage is low. And, understand that you're leasing up a lot of assets which requires capital.

But, over what period of time do you expect the free rent to burn off and the CapEx to go down? At what point do you think you'll get to a more reasonable coverage ratio? And then, how do the asset sales play into that because when you are selling fully leased buildings that's going to probably be dilutive to near-term cash flow?

Yes, that's a good question and we had the same question a year ago. And, a year ago we thought by the end of 2011 we'd be covering the dividend. But then, we did a lot of leasing, we did the DIRECTV deal which has leasing commissions and CapEx, which some of that hit in the fourth quarter of '11. So it is hard to predict exactly what's going to come out. But, our current projections show that for the year of 2012 we should be just about covering the dividend.

It is a little bit cyclical in the sense of quarter by quarter. But, the DIRECTV income for the third building doesn't really hit until fourth quarter or early next year. So, that's a fairly accretive transaction. So, that will clearly push us into the covering range. But, as I said, for 2012 we still think taking everything else the same that we will be basically covering the dividend this year.

Is there a way to break out what the free rent component of your straight line rent is?

Usually about 90% of the straight-line rent.

Is free rent?

Not free rent.

Free rent of the straight-line rent.

Okay, thank you very much.

Chris Caton, Morgan Stanley.

Thanks, good morning. Two-part question on dispositions and acquisitions. First, on dispositions with regard to industrial what are the key factors in weighing either an outright sale or JV? And, would that transaction be subject to closing acquisitions?

And then, John, on the acquisition front, you've talked about wanting to do, and we just heard a little update, on focusing on value-added acquisitions. Can you give us a sense of where the stabilized yields are in some of the situations you're looking at and what type of spread you look for relative to more core acquisitions?

Okay, well Chris, I'm happy to do that. I've written most of this down but if I miss one come back to me, will you? On the industrial, the factors that we're looking at are basically where we achieve the best pricing. We are confident that we can sell and achieve very good pricing if we just sell outright. We've also had a number of players come to us that are on the pension fund side and have said hey, would you consider doing some kind of a venture where it would involve us largely monetizing the industrial.

And then, having an activity to acquire additional industrial as we see fit with us having a modest investment in that ongoing activity. And, a modest call with regard to the acquisition of future properties. Now, I want to say that I've never been a big fan of joint ventures. But, I don't want to rule them out. I want to do what's best for the realization of the most dollars for the Company. Those are the two bookends that we are looking at. That process is probably going to take, Eli, how long?

I think it will take us a solid four months to get to the point where we are knowing clearly where we are headed.

Right. One of the calculations there is if, in the context of a venture, if we view that to be a good situation intellectually but we are able -- let me give you an example. If at the end of the day it was 85% or 95% realization of repatriation, if you will, of the value of the industrial, but it was at a lower overall valuation then we would make the equation that's not a good trade. So, that's where we are going on industrial.

We have a lot of people that have approached us on our industrial. It is just amazing how many folks are out there where we receive so many unsolicited offers at, frankly, at values that are greater than what we valued the industrial at.

On the second point with regard to stabilized yields and what we've achieved to date, we've announced that before. But, you heard us speak to the assets, value add, we are looking at anywhere from 7.5% to 8.5% of stabilized with IRRs near double-digit or better.

On core, and I want to speak to core, we don't see ourselves as being big buyers of core because it has been too pricey. The one exception would be is if we could be successful, we don't know that we will be, but if we could be successful in a profile which included a big discount to replacement cost and rents in place that were significantly below current and below projected future rents when leases roll. Then, that could be interesting if it is a strategic asset.

But, I want to say that our entire investment acquisition thesis is predicated upon investing only in the very best markets where we do receive discounts to replacement, where we do achieve what we hope to be superior returns. And, if our assets that have the physicality to meet the needs of the modern workforce, which the bones of the building and the systems are all important because you got to have legs for the value to go up over time. I think you had a third point and I'm not sure what it was.

I was asking about spreads but I think you hit everything pretty specifically so I appreciate that. Just one last follow-up. Do you think on the industrial, in terms of the value discussions you've had, do you think you can hit $100 a foot in terms of a valuation?

I prefer not to comment on that. We will have the portfolio out in the market soon. And, we do not want to lead -- give any information right now that's going to indicate to buyers what we see the valuation as. I'm very, very confident in a very aggressive core like cap rate. And, if you were to apply that to our incomes associated with those, I think you can derive your own value. And, you certainly would not be short there.

Thanks, guys.

Just to put in perspective the transaction that we did, roughly 192,000 square feet in El Segundo which is industrial building, although highly improved by the tenant. We sold that for $45 million which is $230 -- round numbers $235 a square foot. We were very pleased with that result. Now, that translated to about $220 net to us. But, we are very pleased with that transaction.

That's in no way endeavoring to say that the rest of our industrial will command such a high price. But, that particular asset, the El Segundo property, had rents, in-place rents, that were 38% above current market. And, we achieved very good pricing. So, we feel pretty comfortable that we are going to get very good pricing on the balance of the industrial.

Just to be -- just not to ask a third question here, but the supplemental on page 20, you do have a blended rent $685, is that in place or is that escalated? And, is that a triple-net rent or is there some expenses in there?

All those rents on that page are blended rents. For most of the industrial it's going to be triple-net. But, it is a blended number.

I'm reading the footnote, is that triple -- is that escalated or in place?

It's currently in place.

Thanks, guys.

John Guinee, Stifel Nicolaus.

Thank you. A couple of quick questions. Eli, the strategy that you've outlined, you and John have outlined, sort of implies that once you've got DIRECTV tenancy in and Ameritrade tenancy in and those have got some lease term on them, that they would also be candidates for sale. And, to the extent you can comment on that. And then, also, on your Scripps lease which I think expires in 2027, just what kind of numbers are the private REITs paying these days for good buildings and good credit and long-term tenants?

Let me deal with the first part of that, John. We're not going to comment on specific assets at this point. Until we announce an asset is going to be put up for sale or that we've sold it I don't really want to speculate on what assets we might sell. There are some obvious assets within our portfolio where they are pretty well buttoned down for some period of time.

So, I think it is probably realistic to think that in due course those assets might be in play, if there's any free rent we probably want to burn the free rent off first. But, we also look at the balance between our portfolio and what kind of rents are in place in those transactions and what kind of rents we think that'll occur in the future. More to come on that.

With regard to the Scripps lease expiring in 2027, are we talking about -- is that the building we just sold or is it the one that's also -- or in Del Mar? The cap rate on that was 5.4%.

Is that a private REIT buyer or some other entity?

It's an institutional, not a private REIT, but it is an institutional level buyer.

Okay. And then, Tyler, do you have any intention of redeeming your preferred stock that's in the mid-7s to high-7s? Your preferred shares?

Yes. That's a good question. We've been looking at that. Pricing for us has been in the 7 3/8 range for a while. Looks like it might be going down a bit.

We have the 780s out, it is only $40 million. But, as that pricing gets closer to 7, it becomes more compelling giving you have to add in the fees to do the transaction. So, I guess that's our way of saying we are looking at that and we need a little more movement, I think, to make it make sense for us to do a lot of that. But, something on our radar screen.

Great, thank you.

James Feldman, Bank of America.

Thank you. Tyler, did you say what you think same-store NOI looks like next year based on the guidance?

I didn't, but it is about 3%.

That's on a cash basis?

Yes.

Okay. And then, can you guys talk a little bit more about the development opportunities? Just frame, maybe, how many opportunities are out there and exactly what markets you are thinking about?

This is John, Jamie. In San Diego I mentioned the Sorrento Mesa sub-market there. We have pretty strong demand for high-quality facilities that are above the 60,000, 70,000 square foot range. And so, I could see starting something perhaps on Lot 2 of our Gateway project for about $80 million. We estimate on, based upon the transaction we just did with TD Ameritrade, that would produce, and I think I gave these numbers once before, but somewhere in the early 8%s, 8.5%, 9% on incremental cost and somewhere in the neighborhood of 100 to 150 basis points less than that on total cost.

That's a first year yield, unleveraged. We are also beginning to have discussions, now that we have a full operation in the Bay Area with development expertise, having discussions. We've been sought out by a number of folks in the technology-related fields that are interested in having us take a look at building their campuses for them.

Whether or not those things go together they always take longer than one would imagine. But, I think we've had a lot of tours of our Intuit campus and other campuses that we've done here in Southern California with some of the big users up in the Bay Area. And, I'm comfortable that in due course we will be able to be successful in that effort. Whether that particular initiative will happen this year or not, I don't know.

Then lastly, I mentioned that we have a new hire that I'm unable to announce today because of a confidentiality agreement we have with the current employer. But, we are hiring somebody to run our LA value add and develop its strategy. And, with that individual I'm comfortable that we are going to be able to see, over time, some real results. We think that developing to higher yields in some of these markets is a better play than just buying assets at considerably lower yields.

Okay, and then back to San Francisco, would that be fee development or --?

No, I won't say we won't do fee development. But, I don't see us doing it. I think it is an inappropriate allocation of resources and takes talent and brain power away from that which really creates long-term lasting value. If we do it, it will be to accommodate an existing client or as an entry into a larger relationship with another client, a new client.

Okay, all right. Thank you.

Craig Melman, KeyBanc Capital.

Hi, Jordan Sadler is on the line with me as well. It sounds like you guys have a pretty active acquisition pipeline in San Francisco and Seattle. I'm just curious, do you think the magnitude to get to what we've seen in '10 and '11 in terms of $600 million or $700 million or is that just too much given where pricing is coming in and the opportunities you guys are seeing?

This is Eli. It is hard to say. If you look at the pipeline of properties that are coming right now, it looks like 2012 will have more properties trading, a higher overall transaction volume than we've seen in the past. If you look at the capital environment compared to, call it, the end of last year, Q3 and Q4, I would say the capital environment flattened out in Q4 and has remained flat starting into Q1 here. So, I think we are in a very similar environment that we were in the last half of last year.

Probably some modest changes with respect to the amount of capital pacing deals, modest changes with respect to the number of deals in the market, and a little bit of modest amount of extra debt in the market. So, all that nets out to me as the environment now is about the same as it has been for the last two months.

And, we'll be looking at everything for things that are strategic, for things where we can create value, where we can create NAV per share through our acquisition efforts and our redevelopment efforts. And, to put a number on it, I think it is impossible to put a number on it. And, I know that's where you're trying to get to, but I see us being active right now.

I don't see the door being shut. There was nothing pushing pricing up further at the end of the year last year. In some ways it moderated. And, I think there will be plenty of opportunities. The properties more in the value add, some in the core. So, we will look at a lot of opportunities this year. How many we will execute is up to the nature of each opportunity.

I will add this onto it, Craig, that currently we have negotiations going on. And, I always want to comment that a negotiation is just that. Even though you might be in the final stages, a negotiation isn't a deal until you've signed a PSA and gone through all the due diligence and closed escrow.

So, with that very specific caveat, we have about, in addition to the $77 million asset here in the Los Angeles area that we are confident we will close in the second quarter, we have about another $300 million or so in active negotiations between the Bay Area and Seattle that we think we're making very good progress on. They're terrific assets and the yields are pretty much where our yields have been over the last year or two and these are killer assets. Again, we may or may not end up finalizing them.

That's helpful. Then, just a second question, with regards to San Diego portfolio, what percentage of the square footage or assets, or however you want to cut it up, would be consistent with the medical office assets that you've sold? So, from a price per square foot basis or potential cap rate basis, I'm just trying to get a sense of the breakdown of that portfolio?

That's a mouthful. The only reason I say that because we own so many assets there you really need to drill down. But, I think what has been -- what we've seen here is that assets are beginning to trade at higher dollars. There's a lot of activity in San Diego looking for product. There is a great line of differentiation between true quality product and product that might be pretty good, but not quite at ground, you know, at Main and Main.

And, I would think that the kinds of cap rates that were manifested here on our MOB would be likely to be manifested on our other two MOB properties as well as properties like a significant portion of our holdings down there like Sabre Springs Corporate Center, like our assets in Del Mar, like the Intuit campus. I think all those would trade in that cap rate range based upon what we are seeing today. The others could be plus or minus.

Great, thank you.

Michael Knott, Green Street Advisors.

Hi, guys, a couple questions for you. Tyler, how come you're going to end 2012 at only 93% occupancy given the percent leased is above that today? I was a little surprised by that. Is there some big rollovers coming this year that you don't expect to retain, is that part of the math?

We have two rollovers that are over 100,000 feet. One is a 144,000 square foot lease in Orange County in industrial which we think we will retain. The other is HP in San Diego which we think we won't retain. Whether we get that leased by the end of the year, don't know. Then, the next one down is a 75,000 foot Orange County industrial building that has moved out -- will be moving out here in the first quarter.

We do have expirations of a 1.1 million that we need to re-lease. And, obviously as you get closer to that 94% or 95% occupancy level it is just harder to get that number up much higher than that. Maybe it is a bit conservative, but we feel comfortable with it.

Okay, and then, in terms of office industrial, just curious if you have broken out that portfolio mark to market given the unique circumstances of how your LA building traded. I think it would be good for us to know in terms of trying to value the industrial, is it still about 20% over market and offices closer to zero, is that --?

Do you have that number in your head, Tyler? I know that in our industrial, you recall, we had significant vacancy in the downturn because we had quite a few assets that were expiring at that time that had been leased in a more robust period and had 3% or 4% per annum adjustments. And, we had big roll down in our industrial portfolio. So, maybe you could talk about it generally there, Tyler, you've got a schedule.

I quoted 7% over market for the portfolio. And, our numbers are showing about 6% over for office and 14% over for industrial.

However, I would also comment that what we are seeing is industrial with strength of demand moving quite rapidly. And, whether that 14% turns out to be 4%, or whatever it turns out to be, who knows.

We are very close to that right now in selling our industrial portfolio. And, conditions are quite tight. Like they said earlier on the call vacancy is around 5%. There continues to be plenty of activity and demand on it. I think rents, if we were to try to mark them to a minute, they are up.

And, I think my expectation by the time we're selling this thing is that we should be selling values that people look at as the portfolio is near market, right in the range of market. Might be a little better, might be a little bit worse. But, given the activity we've seen, by the time we get out there I think people will view the market -- people buying the portfolio will view it to be leased largely at market.

Sounds like you already achieved that on the LA sale with a 5% above market there.

Yes, that's a sampling of one. And, we are going to be out in the market looking at values here very shortly. So, I think we will have a much better indication of how accurate that 14%, or whatever that number might be, is indeed in this market.

Okay, and then, just a similar topic to that, any thought about breaking out your same-store NOI performance between office and industrial? You can obviously think about that, but here's another question. My last question would just be, John, with regards to Seattle, you mentioned South Lake Union in your comments. Should we assume some of the deals you're working on up there are maybe in that sub-market?

I'm not prepared to comment on that.

Okay. Thanks guys.

Thanks.

Caitlin Burrows, Credit Suisse.

Hi, how does your guidance reflect your convertible debt given the cap collar they have in place? And, is there share price where additional dilution would be more of a risk?

Yes, for every $2.00 of increase in stock price it is about $0.01 a share. In terms of the -- yes, the strike price is around $36.00, but we have -- the collar on it moves it up to about $42.00.

Okay. Thank you.

Dave Aubuchon, RW Baird.

Yes, thanks, John, relative to your comments regarding a senior-level hire in LA, focusing on that value-add development strategy. Was that ground up development or just sort of trolling for redevelopment opportunities within the broader LA market?

Well, I think initially, Dave, it's going to be value add. This asset that we are buying, the $77 million asset, an asset just down the block recently traded for $500 a foot in round numbers which is, we think, pretty close to replacement. We are buying that asset $242 a foot.

We think there's some real opportunities to reposition that building. Not only because it's been dysfunctional in its ownership and so forth, and they haven't had dollars for TIs, but the market has been very robust. And, we think there's retail opportunities and whatnot. So, that's a true value-add play as I mentioned in my comments.

We think there's some other transactions like that that are out there that we are having some discussions on. Ground up development I think is a ways away in LA. But, I think that in the LA area, obviously the markets we like, in due course, I think that there may be opportunities there. But, I don't see that as something that's happening in the next year.

Okay, just moving down to San Diego. Can you give an update on your strategy and, maybe the activity that you are seeing in the I-15 corridor generally, but Rancho Bernardo Corporate Center specifically. Because you do have a lots of potential there and I think when you bought that asset there was a certain game plan in place, not sure where that stands today.

Yes, that's an asset that frankly has been -- we thought we would have that thing developed some time ago. And, we've had about five people to -- five brides to the altar. And, in each case, we were very close last year, but a company got acquired by another company and they haven't made a decision whether they want to proceed with the plan. In that case it was going to be the existing 300,000 square feet plus up to another 0.5 million square feet, of which half of that would happen concurrently with the initial transaction.

That's kind of on hold. We don't know where that's going. But we are happy to see that Jay Paul with their property, and I forget what they call it there, did a number of transactions and leased that space. So, we think that bodes well for that market.

There's no sizable real square footage available in that market. We do have a number of assets that are very well leased and a couple of smaller ones that are partially leased in that market that we feel we ought to go ahead and re-tenant those which we are in the process of, or at least in negotiation on. Rents have got to move a little bit for any ground up development in that market.

Whereas rents, based upon what we just did with TD Ameritrade and some of the discussions we're having with others in Sorrento Mesa, we think are there for the larger transactions. Larger development meaning plus or minus 100,000 square feet. If you are talking about developing a 20,000 square foot building, I think you'd be out of your mind because there's a lot of 20,000 square foot spaces that people can go.

So, I-15 is the last market, sub-market to move in San Diego?

You know what's funny about -- if you go back, and like Steve Scott pointed out to me a number of times over the years, and if you plot I-15 and you plot Sorrento Mesa, when Sorrento Mesa is on fire, I-15, for some reason in the two-story product, chills a little bit until -- and then the reverse, when the I-15 market's maybe on fire, Sorrento Mesa chills a little bit.

The difference I think this time, and I'm always concerned about people saying it is different this time because in my life, and I've been around longer than most people on this call, there's always something new that comes along. And, it can be good and it can be bad. But, you've got to be watchful.

What I'm pleased by is that with the technology-based companies that seem to populate so much of the West Coast, they're really focused on the kind of work places and the kind of buildings that help them attract and retain their people because you are dealing with high-powered, brainy people. And, they are not looking at space, as has frequently been the case with other users, as a commodity.

They are looking at a campus, or a building that personifies the way they want to use space and the image they want to have. We think that bodes well for Kilroy because we've tended to have very high-quality buildings. So, it is going to be uneven in San Diego, just as it is in LA. But, we are making great improvement down there in leasing and we think we're going to see rental rates increase over the course of this year.

Okay, appreciate that response. Just a few more random questions. Is there any debt attached to the industrial assets?

No.

Okay. The provision for bad debt expense went up in the quarter, Tyler, the reason?

Yes, there was a couple of tenants specifically that were on our watch list. But, we are a little more worried about them so we increased the reserve to preserve 100% for those two tenants.

Any particular market or just spread out?

I think one was in Los Angeles and one was in San Diego.

Okay. The bank term loan maturity that you are looking at to take out the convert is what?

Probably a 4 plus 1.

Okay, and then pricing that you're hearing right now?

Yes, right now we are looking at a floating rate. We haven't decided whether we would fix it or swap it or not. But, on the floating rate basis it's LIBOR plus 175 to 200.

Okay. And then, thoughts about using your ATM. You didn't put that -- you didn't say anything relative to guidance, you obviously did use it in Q4 to lower share price. Just was, I don't know if that was strategic or maybe give your thoughts around the ATM program?

Yes, we're trying to -- we've been buying up property. We bought two properties in the fourth quarter. So, the goal with the ATM was to de-lever a little bit. Obviously, it was a very small amount. But, I think if nothing else changed we would probably continue to target, to raise a little bit of equity capital over the next few quarters.

Depending on where we go with more acquisitions we will have to rethink that. But, we want to manage our leverage. And, we're going to be hopefully closing this office building in the second quarter in Los Angeles. That's one way to do that.

Okay. Thank you, guys.

Ross Nussbaum, UBS.

Hi, guys, it is Jeremy Woods here with Ross. Just one quick question, most of ours have been answered. Is anything with the industrial portfolio contemplated in the 2012 guidance?

No.

No? Okay, thank you.

Dave Rodgers, RBC Capital Markets.

Hi, John, with the acquisitions you talked about that you're looking at today, both in Northern California and Seattle, you had mentioned early in your comments in the prepared remarks, you mentioned a number of sub-markets in Northern California. Are you thinking of moving down the peninsula and is there any change in your Northern California strategy? I didn't hear if you had answered that.

Yes, I figured somebody would catch that. I'm sure everybody has. I figured somebody would ask that question, so, thank you. We don't have anything in escrow in those markets today. We do have some -- we do have a transaction or two that we are looking at.

You might recall earlier in an earlier conference call sometime this past year both when we hired -- when Eli joined us as well as when Mike Sanford who runs San Francisco joined us, both of those two live in that Bay Area, have developed in that Bay Area. I think Eli's bought, probably, and sold more buildings in that area than any person alive given his Spieker days and Broadreach days.

Mike Sanford, 10 years younger, but he has had similar experience. We like some of those markets. We probably should've been earlier in some of those markets. But, we've been very focused on SoMa. And, I don't want to detract from SoMa because we have some other things going on there.

But, I do like some of those markets. And, really when we look at it, Palo Alto is ground zero. So, I hate to use that word, it is the high price $800,000 or more per square foot for those assets. And, you radiate out from there. We believe you want to stay in the influence of Stanford University, close proximity to where key decision-makers live.

And, terrific locations from an accessibility standpoint. Then have a physicality of the assets that respond to the type of tenants that you see in that market. All those things coupled with price per pound and yield make for an interesting play. So, I'm not going to say we're not going to do it, I'm not going to say we are going to do it, but I can tell you that we have our ears and our eyes to the ground.

All right, thank you for the color. And, last question for me, from an operational, or maybe an AFFO perspective, are you still adding free rent at the same level, I guess, to the AFFO statement, we will call it, or are you seeing the burn off of free rent? Do you see any large burn off of free rent during 2012?

We've got the DIRECTV free rent that will go through most of the year. So, not really. There is still a fair amount of free rent in our numbers through this year with the leasing we've recently done.

Thank you.

(Operator Instructions)

Michael Bilerman, Citi.

Hi, thanks, it's Josh Attie. On the industrial -- potential industrial sale. Can you just talk about what your tax basis is in the assets? And, what some strategies could be to offset any gains? Because I noticed there wasn't any acquisition activity in the guidance.

This is Eli. I will take a quick crack at that. Our tax basis is very low. And, gains are something we're going to have to manage very aggressively, very assiduously which we are doing. And, we do have, and we are constantly in the middle of, strategies of how to manage that with respect to gains as well as dilution having properties go out and not having yet identified replacement properties.

So, it is a very complicated matrix that if you look back the last couple of quarters we had a similar level of activity going on where we were buying and selling several things at the same time. I would just tell you that internally we have a team of people focused on precisely how to arrange these transactions, precisely how to time them, precisely how to provide, and this is the most important part, provide a high-level of optionality both on what is going out and when and what is coming in and when.

And, it is a very difficult game to play, in some respects, but once you know how to play it then you can do it and you can execute it very carefully. I would say, looking back on our execution through the end of this year we are very pleased with it. It all worked out. We hit it exactly as we wanted it.

Minimize dilution, minimize any tax gains, did 1031s, we bought properties that we really wanted to buy. We didn't buy anything that we didn't want to buy just because we had to do a 1031. So, it all came together. The bottom line is it is a very rigorous process. We have the team and the system in place to make sure that that all happens. And, we will do the same throughout this year. It will be a complicated transaction, but it will be well managed.

Thanks. That's very helpful. And, Tyler, just a quick question on the guidance. You mentioned ATM issuance earlier. Is there any ATM issuance contemplated in the guidance?

No.

Okay, thank you very much.

Sure.

At this time I would now like to turn hand the conference over to Tyler Rose for closing remarks.

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

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