Kilroy Realty Corp (KRC) 2012 Q2 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Second Quarter 2012 Kilroy Realty Corporation Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we'll 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 call over to Tyler Rose, Chief Financial Officer. You may proceed.

Good morning, everyone. Thank you for joining us. On the call with me today are John Kilroy, our CEO; Jeff Hawken, our COO; Eli Khouri, our CIO; David Simon, our EVP of L.A.; Heidi Roth, our CAO; and Michelle Ngo, our Treasurer.

At the outset I need to say that some the information we'll 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. Jeff will take you through a brief review of conditions in our key markets, and I'll finish up with financial highlights and updated earnings guidance for 2012, then we'll be happy to take your questions. John?

Thanks Tyler, hello everyone and thank you for joining us today. The second quarter continued to be a very active period for the Company. KRC's larger operating platform and expanded management team continued to make meaningful impact on our ability to find and execute growth opportunities with substantial value. While core asset pricing remains very aggressive, we continue to principally focus on a variety of value add acquisitions, opportunities in the best West Coast markets. We're increasingly viewed as a leader in delivering the collaborative workspaces that growing tenants demand. And on a selective basis, we're increasingly comfortable moving forward with new development where market strength and visible demand clearly support the project.

Let's talk about what we've accomplished since our last call. We completed property acquisitions in the greater Seattle markets of Lake Union and Bellevue, adding premier properties with strong rent growth, potential to our Seattle portfolio, increasing it to now to more than 1.7 million square feet. Our newly acquired three building Lake Union waterfront office complex is 99% leased, with in-place rents that are approximately 25% below market. We purchased the campus at a significant discount to replacement cost, with an estimated in-place cash return in the mid 5% range. We expect to capture significant value as the existing leases expire in a sub market that continues to lead the region in growth and tenant demand.

Our new Bellevue office building Skyline Tower, is a 24 story, LEED Silver Class A multi-tenant high-rise with spectacular views, and an irreplaceable location amid Bellevue's most affluent residential and retail neighborhoods. It is adjacent to the transit center, and appeals to both traditional office users and tech and media tenants. The office tower, currently 92% leased, is just two blocks from our existing Key Center office building, that was which purchased well below replacement cost. Based on our original underwriting, the initial cash return is approximately 5%. And following the repositioning of the property through a comprehensive capital improvement and modernization program, we expect the stabilized return to be approximately 6%.

Moving to the Bay Area, we've completed the purchase of two development projects, and we're actively pursuing additional opportunities in the region. With our development background and strong local management of presence, we believe that in select situations we can generate yields 150 to 300 basis points above what we would earn from a comparably fully leased core acquisition property.

First, as we have previously discussed, in the city of Mountain View we are developing a 341,000-square foot office campus for Synopsys under a 15-year lease. Already fully entitled, the project includes two five story Class A buildings designed and pre-registered to meet LEED Gold certification requirements. The project's initial cash return is approximately 6.5%. It is situated in the heart of Silicon Valley with convenient access to both light trail and Caltrain. This is an excellent opportunity to increase our presence in an area that is growing rapidly, and anchored by some of the world's largest technology companies including Google, Facebook and Apple. We are projecting total development costs of approximately $200 million, and expect to complete the project in 2015.

Second, we acquired a development site at 329 Brannan Street in San Francisco's SoMa district for approximately $18.5 million. This is literally at Main and Main. Plans are still being finalized, but with the site zoned for 5.0 FAR coverage, we plan to build a six story office building designed to reflect the prevailing brick and timber character of the neighborhood, including our own properties at 301 and 250 Brannan Street. The building design will incorporate large open floor plates and many other features popular with the creative tenants that dominate the area. Brannan Street corridor is in high demand among the city's many technology and media companies with very limited available space. Our two existing properties there are both fully leased. We expect to complete the entitlement process by year end 2013 and deliver the building in 2015. Our preliminary estimate of total cost for the project is approximately $85 million, with an initial cash return of approximately 8%. Our fully developed basis for this best in class asset will compare very favorably with recent market transactions.

Third, through a combination of our long standing development experience and local Bay Area relationships, we have been selected by the City Council of Redwood City to develop a two building office campus totaling approximately 260,000-square feet in an irreplaceable location. We are currently working with the city to finalize the development agreement and hope to acquire the land later this year. Given early discussions, it may be possible to increase the overall project by almost 40%, or over an additional 100,000 square feet. The site has tremendous visibility and is immediately adjacent to the Caltrain station that is part of the heavily used rail line connecting San Francisco and Silicon Valley. Access by an office tenant to Caltrain station is highly desirable, and there are very few sites remaining in the valley that can offer this amenity. We believe this is the best remaining site near a Caltrain station in the entirety of Silicon Valley. The campus will be designed with all the features that knowledge-based tenants seek in today's modern work environment, and will be ideal for a tenant seeking a new headquarters location. We will develop and own the property with a local partner who have a small minority interest. We currently project a total investment based upon the 260,000-square foot scenario in the $140 million to $150 million range, with a delivery date of 2015 and an initial cash return in the 8% range.

Fourth, we've extended escrow to purchase another 100,000-square foot pre-lease development opportunity in one of the best markets in Silicon Valley. We are under a confidentiality provision and detail due diligence to build a 90,000-square foot building for a tech tenant under a ten-year lease. The total development cost is projected to be approximately $50 million with an initial return in the mid-7% range. We would complete construction in the fourth quarter of 2013. In total, there's four development opportunities in the best San Francisco Bay area markets. Two 100% pre-leased, filling approximately 900,000 square feet, a projected investment of approximately $500 million, and an average initial cash return in the mid-7% range.

Moving to Los Angeles, we are making significant progress here expanding our platform and capturing value added opportunities. Earlier this week, we completed the purchase of Sunset Media Center, a 322,000-square foot 22 story Class A office building located on the corner of Sunset and Vine in the heart of Hollywood for approximately $79 million. The purchase price, which was agreed to in early 2011, represents a 50% discount to replacement costs. At $245 per foot, the acquisition price is also less than half of recent trades in the area. The property is currently 87% leased, with in-place rents approximately 30% below current market levels.

We have plans underway for an extensive renovation of the property that will reposition it into the premiere Hollywood office and media center attractive to a variety of entertainment and media tenants. As with most value add opportunities, occupancy and returns will fluctuate over the next year or so as we complete our renovation. Based on our original projections, the stabilized cash return is expected to be approximately 7%. While the Hollywood market per se is new for us, it embodies very similar characteristics and tenants as many of our other core markets. Our team, particularly David Simon, our new EVP for Los Angeles, and Eli have substantial experience in this area. Hollywood has experienced a substantial revitalization from a residential and retail perspective and remains a critical office location for much of the entertainment industry. We expect to find other opportunities in this market over time.

We've also signed a purchase agreement for a stabilized west L.A. building that will have excellent synergies with our existing west L.A. holdings and our new Hollywood Sunset Media Tower building. We are currently under a confidentiality agreement, but the purchase price is approximately $75 million with $40 million of assumed CMBS debt. It is well leased and is expected to generate an initial cash return of approximately 6.5%. Closing is targeted for the end of the third quarter subject to the loan assumption.

From a leasing perspective, we made good progress during the quarter, signing new or renewing leases on approximately 850,000 square feet of space. Among the highlights, we signed a 10-year lease for 123,000 square feet with Concur, a travel and expense management company, at Key Center in Bellevue, which is now 93% leased. About 100,000 square feet of that space is currently occupied by tenants with upcoming expirations. We've made progress at our 370 Third Street redevelopment project in San Francisco, where we are in lease negotiations with a ground floor tenant and in serious discussions with several other perspective tenants for a good portion of the remainder of the vacant space. And in San Diego, we are making excellent progress backfilling the former HP space in Del Mar. We have two LOIs there with tenants that would take four of the five floors. Overall, our pipeline of LOIs now totals approximately 400,000 square feet. GAAP rents are projected to be up about 17% on those transactions.

We continue to have four properties in our redevelopment portfolio. Cash rent will begin on the DirecTV space on December 1 of this year, although revenue recognition will depend on when the tenant completes its improvements. TD Ameritrade is expected to take occupancy at the end of the third quarter, and DeVry has now moved into its new space in Long Beach. And I mentioned, we are making good progress at 370 Third. At stabilization, these buildings will generate approximately $22 million in cash NOI.

With regard to the sale of our industrial portfolio, the process is going very well. We've received a number of bids for the entirety of the portfolio, and several for various portions of the portfolio. We are in the midst of evaluating the best execution and expect to complete one or more transactions later this year. As we've previously discussed, we also maintain an active portfolio review process to identify potential future disposition candidates. We anticipate additional property dispositions that could generate another $100 million to $200 million over the next 12 months.

As my comments today demonstrate, we are extremely active. Over the past two years, we have built organizational strength and capacity and are taking full advantage of our growing enterprise to capitalize on market opportunities and to continue to position the Company for long-term growth. While there remains considerable uncertainty in the macro environment which can impact decision making, our core real estate markets are all showing improvement and all have had positive job growth over the last year. At Bay Area and Seattle, we continue to see increasing demand for space driven by rapidly growing tech and media industries and all the support businesses they generate. In our southern California markets, we are seeing steady improvement in real estate fundamentals.

As we have increased our visibility in regional capabilities, our expanded management team is finding more value add in first looked opportunities. We are harvesting mature investments, recycling capital into higher potential assets and focusing on long-term value creation. And we have done it in a financially disciplined manner. While in the past, I would review our individual sub markets, going forward, Jeff is going to cover that for us. Jeff?

Thanks, John. Hello everyone. Our core real estate markets continue to show improvement from a year ago, although the rate of improvement varies from market to market. Lead by technology, entertainment, tourism, and healthcare, California had 2% job growth over the past 12 months, significantly faster than that of the nation. As John mentioned, all of our core markets including Seattle, San Francisco, Los Angeles, Orange County and San Diego have experienced positive job creation over the past 12 months.

Let me review each of our five regions starting with San Diego. San Diego experienced positive absorption in the second quarter marking nearly three years of improving fundamentals in the area. We continue to see declines in the availability of large contiguous blocks of Class A space in select sub markets. As John mentioned, we are making good progress in Del Mar with two LOIs in place to backfill four of the five HP floors. As we previously reported, we had two significant San Diego lease expirations in the quarter totalling approximately 235,000 square feet, which impacted our overall San Diego occupancy. Our San Diego portfolio is currently 89% leased, and 92% committed.

In Orange County, the industrial market continued to improve with vacancy now at 4.8%, as a result of 4.4 million square feet of positive absorption since the second quarter of 2010. The Orange County office market saw a significant positive absorption in the second quarter that totaled 950,000 square feet driven by research-oriented businesses. Orange County's unemployment rate continues to decline and is now 7.9%. During the quarter, a 153,000-square foot industrial tenant defaulted and moved out of its space. This lowered our industrial occupancy to 93%. Annual NOI impact of this lease was approximately $850,000. From a re-leasing perspective, current market rents are about 20% higher than the rate under the previous lease. Overall, our Orange County office portfolio is 96% leased and our industrial portfolio is 93% leased.

Moving north. West Los Angeles remains the strongest sub market in the greater L.A. metro area supported by an improving entertainment industry. We are 98% leased in West L.A. Our South Bay markets El Segundo and Long Beach both have positive net absorption in the quarter, and we were 96% on a combined basis in these markets. On the 101 corridor, we are 88% leased in our Calabasas properties, 91% leased in our Thousand Oaks property, 15% leased in our 265,000-square foot complex in Camarillo. Overall, our 101 corridor properties totalling 651,000 square feet are 59% leased.

San Francisco remains our top performing market and arguably the strongest in the country, with continued demand from the technology and media sectors. In 2011, there were nine leasing transactions over 100,000 square feet in San Francisco. There have already been another nine through the first half of 2012, and market demand remains strong at more than 2.5 million square feet. Vacancy rates continue to decline, and unlike other markets in the country San Francisco has experienced tremendous rental growth with rates up more than 85% in SoMa, on a triple net basis since 2009.

In the Silicon Valley, fundamentals are also very strong, although absorption was slightly negative in the second quarter. While the pace of activity slowed from record pace in prior quarters, brokers are reporting continued increases in asking rates, increased third quarter activity, and limited available space and quality buildings. Our San Francisco Bay Area portfolio now represents approximately 28% of our pro forma stabilized and annualized NOI. Overall, our stabilized Bay Area properties are 93% leased.

Seattle remains our second best performing market with demand principally driven by technology, other knowledge-driven industries, and the fire category. The East Side and Lake Union markets remain the preferred choice for tenants. The Bellevue market continues to tighten as evidenced by the 123,000-square foot 10-year headquarters lease we signed with Concur Technologies in the second quarter. There is now only one space on the market of over 50,000 square feet. Our recent transaction with Concur was the largest lease in the market in over three years and demonstrates the desirability of Bellevue's housing, transportation, and retail amenities. In greater Seattle, our overall portfolio is 95% leased, with our East Side properties 92% leased, and our Lake Union properties 99% leased. Put in the completion of our recent acquisitions, Seattle generates 12% of our NOI on a pro forma basis. That's an update on our markets, now I'll pass the call to Tyler who will cover our financial results in more detail. Tyler?

Thanks Jeff. FFO was $0.55 per share in the second quarter, and $1.04 for the first six months of the year. Those results included $0.03 of acquisition-related dispense, higher public company and IT costs, the issuance of 576,000 shares under our ATM program, and the delayed closing of our recent acquisitions. We ended the second quarter with a stabilized occupancy at 90%. That's down from 91.6% at the end of the first quarter.

As Jeff mentioned, occupancy decreased in the quarter for two main reasons. The first was two lease expirations in San Diego, HP in Del Mar, and Northrop in Rancho Bernardo. Those reduced occupancy by roughly 150 basis points. We also had an industrial tenant default during the period. This had no meaningful economic impact in the second quarter, but reduced occupancy by 100 basis points. This is partially offset by 60 basis points of occupancy gains in the operating portfolio. As of today, our operating portfolio is 91% leased.

Same store NOI for the second quarter was down 0.2% on a GAAP basis and 0.3% on a cash basis. Second quarter 2011 NOI included about $0.01 per share from a one-time payment related to a tenant default. And second quarter of 2012 NOI includes about $0.01 a share of higher one-time expenses related to an electrical malfunction in one of our buildings for which we are pursuing an insurance claim. Excluding those two items, our GAAP and cash same store NOI would have been up approximately 2.5%. For the first six months of the year, GAAP NOI was up 3.7% and cash NOI was up 4.2%.

We project that third quarter same store results will be relatively flat given lower occupancy, but will increase again in the fourth quarter excluding any one-time items. Second quarter operating expenses were higher than the first quarter by about $0.02, $0.01 related to the electrical issue I just mentioned, and $0.01 related to higher utility costs, property management expenses and maintenance costs. Rents at our 860,000-square feet in the second quarter leasing, we're up 13% on a GAAP basis and 6% on a cash basis. As John mentioned, rents on our LOIs are up 17%. We estimate that rent levels in our overall portfolio are approximately 3% over market, reflecting a significant improvement from 10% a year ago.

As I mentioned during the second quarter, we also issued approximately $27 million of equity under our ATM program, at a weighted average price of $46.05. In June, we took advantage of low long-term rates, and closed a 15-year $97 million mortgage secured by office properties in Orange County and Los Angeles. The mortgage had an interest rate of 4.48%. We used the loan proceeds to pay down a portion of the balance on our credit facility. We also assumed three loans in connection with our acquisitions totaling $172 million. As of today, taking into account all of our recent activity, we have approximately $240 million drawn on our bank line. With the pending activity that John has outlined, we estimated that we would have about $375 million outstanding on our line at the end of the year before proceeds from the sale of our industrial portfolio and assuming no additional funding.

Over the past several years, we've significantly grown the Company in terms of new assets and markets. With this, up come added people and opportunities, to further position the Company for the future we're in the process of implementing a new information technology backbone to accommodate increased accounting, property management and construction activities. This will add about $0.01 to our 2012 G&A budget.

Now let's discuss updated guidance for 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 guidance reflects information and market intelligence as we know of it today. Any significant shifts in the economy or our markets going forward could have a meaningful impact on the results in ways not currently reflected in our analysis.

With those caveats, our assumptions are as follows. Our guidance midpoint on last quarter's call was $2.32 per share. Based on our most recent acquisitions and the planned sale of the industrial portfolio, we are projecting an occupancy rate at year-end 2012 of 92%, subject to the impact of any additional acquisitions and dispositions. There are a lot of other moving pieces that are impacting our numbers including higher IT costs, slower than planned acquisition closings, delay in revenue recognition on two of our redevelopment projects, positive impact of new acquisitions, and lower financing costs. Taking together these move our midpoint to $2.30 per share. Not included in that $2.30 midpoint, are $0.02 of dilution from the anticipated sale of our industrial portfolio in the fourth quarter and a projected $0.02 of additional acquisition-related expenses in the second half. So taking those two adjustments into consideration, our midpoint moves to $2.26 per share. From there we are providing an updated 2012 FFO guidance range of $2.21 to $2.31 per share. That's the latest news from KRC, now I'll be happy to take your questions. Operator?

Thank you.

(Operator Instructions)

Craig Mailman from KeyBanc.

Good afternoon guys. Just curious if you could give a little more color on the state of the industrial side. I know you said it's going well on how the bids for portfolio and break up. What do you guys think the updated timing could be for a portfolio sell versus sort of a break up, and in a break up sell is there enough demand for all the parts of it at this point or is there a lot of overlap in what people want to buy?

This is Eli and I'll try to address that, then if John of Tyler has further comments we can. Look, the first thing I'd say is we're in the middle of a process, a very confidential process and a highly competitive process. So we really need to limit our comments. I think as John already said, we have a significant bids and a lot of interest in both the full portfolio purchase as well as sub portfolios covering the entire portfolio when you add those sub portfolios up. We fully expect to execute a very strong transaction this year.

Tyler mentioned the fourth quarter, and I think that is entirely realistic. I don't think we should comment much further given where we are in the process. I would just say, I don't think the timing changes much between a full portfolio of sale or something that is sold in tranches. But I would just conclude by saying, that I think we're very satisfied with the way things are going, and where we are, and we'll just keep you posted as the process unfolds.

Is --

Craig, this is John, just one added comment. Remember that a lot of these buildings we want to do a 1031 on because of the tax position. So if there are delays, then that would be probably triggered by Kilroy wanting to accommodate our tax position as opposed to the interest of people to close this year. We're confident that we can close it all this year. We just want to be sure that we're being tax efficient.

Yes.

I know you guys had said you were going to tranche it previously. Curious though, did the industrial defaulter during the quarter cause any of the buyers to take a step back and try to retreat or is that a non issue?

No. No, that's an opportunity. Because as Tyler mentioned or Jeff mentioned, it's -- the current market's 20% over the lease that was vacated.

Okay. And then just as -- sorry. And then just as I look at where you guys stand from potential line outstanding at year-end versus kind of the proceeds you can get from the industrial sale when it does close, just curious why you guys hit the ATM this quarter?

Well, as we've said all along as we've been buying properties, we want to remain leverage neutral to the extent we can. Obviously selling the industrial will help us do that. But we acquired a fair amount of properties and we wanted to take advantage of that.

Okay. That's fair --

I would, I would add to that Craig, this is John again, that what we're seeing are some pretty good opportunities in the market. We're seeing a number of non-marketed transactions right now that we think are pretty interesting. And we want to make sure we have plenty of power to execute.

Okay. Then I know you said you were looking at a couple more Bay Area redev and development opportunities. How expended would you want to get with the development pipeline in San Francisco at this point in the cycle?

Well, it's obviously, we want to spread it out with regard to timing and with regard to markets as we've mentioned. We have four development opportunities up there right now. One's in the city, three in the best markets of the Silicon Valley, all share commonality that they have strong transportation components, which is we're very focused on because of the modern workforce needing that. But if it's pre-leased and it's a credit tenants then we feel pretty comfortable. We're not going to hanging out on a massive amount of spec building. We've never done that. We don't intend to do that.

Great. Thank you.

Jamie Feldman from Banc of America, Merrill Lynch.

Great, thank you. I was hoping you could talk a little bit more about the sentiment among tech and media tenants. Our understanding talking to brokers is that there's been a little bit of air taken out of the market since the Facebook IPO and then just some of the earnings releases we've seen this quarter from some of the tech companies. What's kind of the latest sense of things out there?

Well Jamie, I'll start off and then I'm going to turn it over to Eli. But just the tech related job growth has been very powerful. It's more diverse and deeper than before. And it's really changed the complexion of the San Francisco economy. And if you take a look at -- I'm curious your comments, some of the air has been taken out of it. Facebook, sure that was a disappointment. But right now we're dealing with more people that have balance sheets in the Sonoma and related markets, I'll let Eli speak about the valley, than we've ever seen or the market's ever seen.

There have been, as Jeff noted in his comments there were nine transactions of 100,000 square feet or more in 2011 in the city. There have been 10 or, 9 or 10 so far this year and there are quite a few more and there are innumerable numbers that are in the 60,000-square foot range or 50,000-foot range. Most, many of whom have very strong balance sheets. So we're seeing increased demand. I'm looking at a report that the CAC brokerage firm just put together. CAC Group, and it deals with large tech companies that are taking significant space or are in the market to take significant space in San Francisco, as well as completed deals and so forth. And what the pending transactions are in the market, and all of those things are up very significantly over last year, and last year was the banner year.

So we're seeing very strong demand, and I'm not going to say the trees grow to the sky, but we're pretty enthused about our position. Now, with regard to the valley, I know there's been some comments that people have made with has the valley lost some steam or it hasn't-- it didn't have the big absorption in the second quarter that it's had previously. And Eli maybe you could comment on that.

Yes, and the status sitting out there now, first of all, we're very focused within the valley as we've talked about several times. There's places you really want to be and there's places you don't want to be as much. And Kilroy personally is very focused on being in the best -- with the best product, in the best locations and the best markets. And so we feel like where we're positioned is very good. A lot of what you're seeing, I believe with respect to this quote-unquote stat, this second quarter is timing consideration. There were a huge number of deals that came together in late 2011 and early 2012, and they all kind of consolidated at the same time, and then there's some consolidation going around that.

Now, in the third quarter, there are several deals that will be announced that are really all ready inked or about to be inked. Significant deals Dell and Amazon are taking a significant number of spaces. There's another tenant that I won't mention taking another significant amount of space, and there are several many other deals in the pipeline behind that. So it doesn't appear that there's -- there's going to be very positive momentum that's going to show up in the third quarter. So and you look at the level of activity that was in the end of '11 and early 2012, and that was a huge amount of activity. Even something that was less than that is still very, very healthy in the pipeline. Behind that continues to look, where we sit, looking at the pipeline now, is does look healthy. So I think the second quarter so far looks to be a timing gap, so.

And then in terms of Seattle, especially where you've been investing?

Well, Seattle we're seeing very strong demand. And it's the sort of the same suspects of many of the same kind of companies. Interestingly, a lot of folks that are down in the valley and in the city of San Francisco are moving up and having expanded operations up in the northwest. Particularly on the east side and then of course, over in the Lake Union area. And then what is also happening there is you end up with a lot of companies that service and support these that are expanding as well. That's one of the reasons we bought Skyline Tower. We see the opportunity to take a building that has good bones. It had a lot of money spent on its core, and on its redoing the bathrooms and all the systems and all the rest that we go in and change the cosmetics of and really reposition so that it's a crossover building, as we call it, which appeals to both the tech tenants -- media tenants as well as the historic kind of financial lawyers and that sort of thing.

In that market right now, there is about 1.8 million square feet of -- amongst the top tenants in the market in the greater Seattle. And they range from healthcare and gaming and the Amazon's of the world, as well as some of the, the accountancy firms, and eBays, and so on. Broad cross section of people. I can tell you that in the buildings that we've bought about, Eli 400,000 feet is that Fremont in the aggregate?

Yes. Are roughly.

Yes where we're essentially leased. We have a group that's going to get out, wants to get out early. We already have the space committed at very significantly higher rents. And we're just, we're seeing great demand. We're very enthused with our position up there.

Okay. Thanks and then just turning back to the guidance for Tyler. I'm just trying to get a sense of kind of your internal growth outlook now versus the prior guidance? Do you have a same store NOI estimate? And how does that compare to your prior number?

Yes, I think the initial number at the beginning of the year was roughly 3% on a cash basis for the year. We had a big first quarter, some of that was due to some other income. And then we have down second quarter, which again was some of that was one time negatives. And so our goal -- our forecast for the end of the year probably has come down a bit given the higher expenses. But it's in that 2% range roughly.

So 100 basis points lower?

Roughly, 2% to 3% from an overall annual perspective. As I mentioned in my comments, the third quarter will be relatively flat and the fourth quarter should be up.

Okay. And then if you were to get some of that insurance money back for the electrical issue you'd mentioned, is that in your numbers or would that be upside?

That would be upside.

And what do you think the magnitude could be?

Well, it was about $0.01of loss, and I don't know, I hate to handicap it at this point.

Okay. All right. Thank you.

Ross Nussbaum from UBS.

Hello, everyone I'm here with Gabe Hilmoe. John, what would you say to some of your critics you would say your acquisition redevelopment pace is a little rapid and maybe you should slow down and digest what you've got? Do you think that there's any validity to that or do you feel comfortable that you've got more than enough capacity both from a management perspective as well as a systems and leasing perspective to take care of what you've already done?

I haven't heard that criticism and what I would say to anybody who's concerned about that is that most people who know me know that I'm kind of a control freak or I like people who are control freaks. I like to make sure that we are totally in control. I think we have, without question, the best management team up and down the West Coast. As you've seen, we've added top people throughout Seattle, San Francisco, Silicon Valley, now down in L.A. with David Simon, I think we have the best value of that guy on the planet. We've always had terrific people throughout Southern California. And of course, it's been reflected a little bit in our G&A and it's been reflected in what Tyler mentioned that we're going to spend about $0.01 a share upgrading our IT systems. And of course, we'll parallel the existing systems while we get up and running on the new things.

We've invested very strongly in talent throughout the Company. And Jeff and his team have done a magnificent job integrating that in. I don't see where we've missed a beat. That doesn't mean that we can't miss it here or there. But I'm very pleased, somebody -- the old questions when you were out doing an IPO, what keeps you up at night? Well, I always have a lot of things that keep me up, and now I say it starts with six kids. But moving from that it's are we doing the right things? Are we making the right decisions? Are we managing our assets correctly?

And I think if we take a look at the -- there were some people who were a little bit skeptical when we first bought 303 Second Street in San Francisco, and said well Kilroy what are you doing in San Francisco? You don't know San Francisco, et cetera, et cetera. We're now the largest owners of SoMa. We've done a terrific job there. The team's done a great job. Similar kind of questions came up when we were in Seattle. Is Seattle the place to be? Seattle seems like it's been a little bit behind. You didn't do that well when one asset out by the airport in Seattle.

And I think what we've demonstrated there is we've bought the best assets. We've been very disciplined. I'm very happy with our acquisition activity and we're matching it very nicely, I think with our disposition activity much more aggressive in evaluating which assets should be sold for one reason or another. So I think we have, without question, a team -- I've always been very proud of our team. We have an amazing team now, and they're integrating very nicely. We have a quarterly group of all our regional managers, plus our operating heads that get together and talk about best practices. Talk about what works. What they're seeing. Developing new ideas and strategies, and I think it's really paying off. So I'm quite pleased with that.

Okay.

Chris Caton with Morgan Stanley.

Hello John, just thought I'd follow-up on that, on kind of uses of capital. You talked about redevelopment and development in the valley and the city. It would seem to us that there's more on the market for sale from a stabilized asset perspective than there ever has been in a cycle in San Francisco. Would you contemplate taking on some stabilized assets? Or is pricing still at a point where you don't think that's a good use of capital right now?

Well, let me give you an example. I'd love to buy more stabilized assets. I'd love to buy more of the Fremonts of the world where basically we don't have to do anything. It's got great credit. It's fully leased. The rents are way below market. And you just wait for a few years and the rents magically improve. At least that's the theory. The problem is that what we seen now is the pricing in the city has gotten so aggressive for the kinds of assets we feel comfortable owning because we're so about location and physicality. And physicality is, can the asset really stand the test of time and be attractive to the modern tenant that requires certain physical requirements? Some of the buildings do, some of them don't. If they don't, we won't touch it.

With regard to a case in point. The 329 Brannan building that we're going to be developing, we're going to be in there for around $500 a foot. We're going to have the best, at the best location on Brannan Street, the best building on Brannan Street. And there's a building that's being transacted right now that's a good building, nowhere near as good as this and that building is going for $6 -- what?

$615 a foot.

About $615 a foot. So we're going to be over $115 a foot less, and take advantage of I think a lot more upside with the location and the product we have, and obviously end up -- that's why it's reflective of about an 8% going in yield as opposed to a yield on our acquisition that's in the 5% range or less. Maybe it's in the high 4% range. We looked at 555 Mission. Love the building, fantastic, their [mutition] started a great job. Fantastic asset. But in the early forward cap rates and we don't even think it gets to a 6 RR, we're not going to buy that. We don't see how -- that becomes an albatross around our neck. So, when we take a look at development or redevelopment, it's because we feel comfortable that we have a -- not only the team to execute, but a plan by which we can move that asset into much higher yielding than we can in the current acquisitions.

Now at the same time, we announced on this call that we're acquiring an asset in West L.A., and it's a going in yield of about 6.5% and we have a plan that we think is going to substantially increase that over time. But that was a very limited marketed deal and we had some particularly strong benefits, if you will, by us being the acquirer. So love to acquire more existing assets. We're looking at a number of them. But on the trophy type properties, I just don't see how it's going to make sense for us with the pricing that exists today.

And so you don't think the supply of available -- or properties for sale would swamp demand and you might be able to swoop in and get a property at a fair price?

Well if that happens, one of the things that we always pride ourselves on being is very agile. And we're going to acquire when it makes sense. We're going to redevelopment or develop when it makes sense. And we're going to do none of the above when none of them makes sense. But to put it in perspective, if we just look at top tier one competitor space in San Francisco, as you know, in San Francisco right now, Tishman Speyer has Foundry III under construction. That's roughly 250,000 feet. It's going to be delivered sometime first quarter of 2014. I would imagine they'll probably get that pre-leased during construction. It's a great location. Wish we were developing it.

There's 535 Mission, which is for sale. And that's a property right next to our 100 Mission building. We look a look at that at it, it's not our cup of tea. It's a building that has very small floors that we don't think are as attractive to the broad -- to the great majority of people that are looking for space in that market. It would -- a 100,000-foot user would need like 12 floors. So that doesn't really have the collaborative sort of space that most tenants are looking for today. So I don't know when that one gets built, who knows. But I don't think it's going to really compete with the collaborative type tech and media. There's another site that is, and by the way 535 Mission in round numbers is around 350,000 feet, or something like that?

Yes.

And then there's 222 Second Street, which is also owned by Tishman Speyer. Our understanding is they're not going to pull any trigger on until they've substantially leased foundry three, at least that's what the brokers tell us, that's over at 222 Second Street. That's a 27 story building. I think it's more of a financial type building than -- not because of its height but because of its floor plates and so forth. So I don't know when that gets built. And there's the 350 Mission building which is in the market, which can be delivered in about 24 months. Which actually I think that one is one that would makes sense, because it has big floor plates. It's side loaded, it right in a terrific corner location, and would be very much appealing to, what I call the crossover crowd, which is whether it's lawyers or, or attorney, or rather accountants or the technology people.

So all in all those four buildings, can deliver about, round numbers 1.2 million square feet, of which 250,000 is under construction and the others all want to start construction. Somebody's got to finance them or have the money to pull the trigger. My bet is, my guess would be, you might see two of those buildings under construction at any given time unless the ones under construction are fully leased and then you'd see more. So I don't think you're going to see construction overwhelm the existing inventory. It's a very small part. SoMa is about 30 million square feet or south of market is about 30 million square feet, and we're talking about roughly 3%, 3.5% potential supply over the two, couple three years.

Thanks very much, John, appreciate it.

Josh Attie from Citi.

Thank you. From a capital perspective, how should we think about the next 12 to 18 months? Should we assume it's a majority of the asset sale proceeds are used to 1031 into acquisitions and that the $500 million of development projects that you spoke about earlier in the call are funded mainly with new equity given you desire to keep growth leverage neutral?

Well, yes. I think generally the combination of the dispositions and equity and debt to keep our leverage neutral, and it depends on which disposition opportunities we have and the timing of them and whether they are 1031s or not. So it's a complicated calculation. And we'll be providing more guidance on 2013 at the end of the year. But in the meantime, I think the strategy is leverage neutral in general with dispositions and some equity when necessary.

Well I guess it seems like the majority of the asset sale proceeds have tax issues so those would need to be reinvested through acquisitions. Is that correct?

No it depends -- this is John, Josh. It depends whether we sell some of the stuff that we've bought in the last couple years. All things remain -- from our standpoint we reviewed --we're agnostic with regard to any particular building. We have no mother fixation with regard to any specific asset.

Can you talk about the size of the acquisition pipeline that you're looking at? It seems like you could have a lot of money coming in the door the next 12 months?

I think we'll -- I think there are plenty of opportunities to accommodate the 1031 exchanges out of the level of assets sales we've been talking about.

Yes.

And just to be clear on that, in terms of, if you're thinking of the industrial, we have things that we've already purchased which we can do reverse exchanges. So we don't necessarily need to buy the full value of the industrial portfolio just to make the industrial portfolio tax situation work.

Okay. And separately, if I could question on rent spreads. It looks like the rent spreads improved a lot and so did the mark to market. Can you just talk qualitatively how much of that do you think is improvement in the underlying fundamentals of your market? How much of it is having a different product mix since you've added a lot to the portfolio? And how much is just the vintage of what's rolling?

Well, a couple of things. One is that there obviously has been very strong demand in these key markets that we've been in. And with the expansion into San Francisco area, and into Seattle we've seen a very strong upward pressure on demand and obviously that translates into rates. The other thing I think we've been -- that I've been very happy with is that we are very focused. We think we know. I mean, after all, the Company was started by my father years ago with dealing with aerospace companies and they were the technology companies of that era.

And so technology is something that we understand, and through all our markets and I think we appeal very well to the technology crowd and to the modern collaborative workforce crowd. Because we buy or build buildings that respond to their needs, and we manage them accordingly. So I think that's been very helpful. And then I think the other thing that we've been very strong on is in the transportation side of things, the technology type people have higher densities. Sometimes as many as 12 per thousand in some of these big users as contrasted with the old lawyers and their accountants at 3 or 4 per thousand. So obviously you've got to get people to and from work. Transportation becomes key. 24/7 environment becomes key. Housing optionality becomes key. And the combination of those things are something that we're very focused on when we acquire and/or develop, and I think that's paying dividends to us.

Okay. Thank you very much.

George Auerbach from ISI.

Thanks, good afternoon everyone. John, the construction of progress balance today is around 5% of (technical difficulty) add in the land balance it's probably close to 10%, so if you're --

Sorry George, George you're cutting out for some reason. I don't know if you're on headset or what, but I can only hear about a third of what you said.

Okay. Thanks. I used the handset now. I guess the construction and progress balance is around 5% of your enterprise value, and if you add in the land back, it's probably closer to 10%. Just trying to think about how you think through how much development risk you want to have as a percentage of the balance sheet going forward?

Well, we talked a little bit about this before in a previous call with regard to -- we have various covenants and so forth with regard to our lenders. We have various, I don't know if they're called covenants or at least -- essentially covenants or things you want to monitor with regard to our bond. We don't want to get anywhere near any of that. I look at this as -- if the development is pre-leased, that's a whole different issue than if it's spec. I don't see us running around doing spec buildings everywhere. I think that's not an appropriate strategy for this Company.

It's never been something that we have done in mass. I'm not afraid to start this building over on Bran Street, but before we pull the trigger on it, we're going to assess what the environment is at that particular time. So we're going to be disciplined as we always have been, and we're going to be keeping an eye on being very conservative with regard to the balance sheet and with regard to any covenants we have with either with our bank line and/or essentially covenants or the equivalent with regard to our investment grade credit rating.

Okay. And you mentioned that aside from the or above the industrial sales, you thought you could sell maybe $100 million or $200 million of assets over the next 12 months. I guess on the last call, that number -- the total range was closer to $500 million to $700 million. I guess, is the lower range just a function of timing? Is it a function of maybe less acquisitions you want to do in the next 12 months? Or how should we think about the kind of lower disposition range going forward?

I'm not sure it's lower, I think we were probably looking at the combination of the industrial and of another $200 million to get to sort of a $500 million to $600 million range. I don't think it was -- I don't think we, if we, I think if we, I don't think we misspoke, but it wasn't, it wasn't -- (multiple speakers)

to reduce the projection of dispositions, I think you might be being too precise in terms of the guidance there.

We haven't pulled back on anything that's we've been contemplating.

Okay. Thank you.

Michael Knott from Green Street Advisors.

Hello guys, just thinking about dispositions going forward. If you're exiting the Orange County industrial portfolio as you look at your handful of office properties in Orange County, why continue to own office here in Orange County?

We may not.

Okay. So you said earlier everything's on the table and that may be something that you'd think about.

I don't know how to say this any differently that it's -- there's not like a home where you've got a wife and children and grandma's living in the guest cottage. This is a business, and if we need -- if we think the best thing to do is to exit a market, we exited that building in Seattle, which we wanted to get out of for a long time and now we're back in Seattle in the right areas, and so forth. Orange County you've heard me say this a million time Michael. As have others.

You've got Don Brandt. Don Brandt is the king of Orange County. And when you've got somebody that's that dominant of a player, you've got to be very selective. I don't see how you can do in bulk unless you're a just a market timer to get in and get out. And that's not really the business we're in. We've got some little office buildings down there, which are kind of de minimis with regard to the enterprise. We've got a really nice building at 22 Michelson that we bought -- we got at a really good price given what the quality of the building and so forth. And it could be that that building at some particular point is better in somebody else's portfolio than ours.

Okay. Thanks for that. And then I think may have missed this in Jeff's comments. But can you just maybe quickly touch on the re-leasing prospects in San Diego? And then also, are there any other known move outs in the roll in the next year or two that might be worth talking about?

Yes, well Jeff do you want to handle the first point?

Yes so Michael in San Diego, I think I mentioned we've got two LOIs that get us the majority of the space of HP that vacated earlier this year. And I'm anticipating that will move in the fourth quarter of this year. And then on the two buildings from Northrop, we have activity on that space as well as other spaces available in the San Diego market. So we're feeling really good about the level of activity and tours, and so we're very comfortable that we're moving in the right direction there.

In terms of additional give backs, we've got about 350,000 square feet remaining this year. And we've got one industrial property that we expect to have given back in the fourth quarter. And if we kind of roll to 2013, now we don't have too many large spaces. I think we've got one over 100,000 square feet in industrial side, and one over 100,000 in the office. And as we mentioned up in Seattle the Concur has already re-leased about 100,000 square feet of space coming back next year. So it's a little early now for 2013, but we've got a lot of activity and we feel like we're being very proactive.

Okay. Thanks. And then last question for me would be -- John before you've mentioned that maybe longer term you might be more of a 50/50 in terms of geographic split North of L.A. and South of L.A. and South. You've obviously made a lot of progress on that sooner than probably most people would have thought. Any additional thoughts on that? Or thoughts with respect to -- I know there's a bunch of Seattle properties that either recently were on the market or may still be on the market that Beacon is selling and just any thoughts on whether you'll be looking at those to expand that -- to get closer to that 50% waiting?

Well, as I've said before, it's not a magic number. That sort of felt right. Obviously we work for the shareholders. We also keep our eye on what -- the way things look from a bond capacity, because that effectively allows us to borrow when we borrow at lower costs, which obviously helps shareholders. And I think that 50/50 sort of So Cal and north of So Cal feels about right. We're getting pretty close to that particularly with the sale of the industrial and a few of things we're talking about development-wise up north. Those are not rigid.

We obviously have more development that will occur down in San Diego in due course. And -- but there's not -- there's nothing that's magic about this. I can tell you that we push back from most acquisition deals, because we either don't like the physicality. When we make a quick decision we don't like the location, or we don't like the physicality. Or we can't get comfortable with regard to the numbers. We've looked at a number of things in Bellevue and elsewhere, and have had the opportunity to sort of be first choice, if you will. But if pricing doesn't make sense, then we're just not going to pull the trigger.

With regard to some of the Company that you mentioned, they have a lot of stuff downtown. And some really nice buildings and some that are more challenged. I'm not personally a giant believer in the CBD of Seattle. Not because there aren't some really good buildings where you can't make money over time. I think you can. But it's not where the kind of the real growth is going in a big way. I'd love to own more in Lake Union. I'd love to own more on the east side at the right location. Not the suburbia locations, and we'll see.

And they'll come points in the -- any different inflexion points in the economy where if we continue to have and maintain as I want to make sure we do, our balance sheet, there will be times when others perhaps are a little bit nervous about buying. And maybe we'll end up with another 303 Second Street where we were able to see something a little bit earlier, and really do a good job in acquiring. So it's -- we're not trying to buy in bulk. We're trying to buy very selective and stay very true to the tenants upon which we operate the Company and which we -- Eli and David and everybody else has reinforced as they've joined the team, very focused.

Thank you.

Tom Trujillo from Banc of America Merrill Lynch.

Hello guys, thanks for taking the question. Tyler, there's obviously a lot of moving parts to the Company right now. Do you guys have kind of a run rate for your debt to EBITDA and coverage if you put any future acquisitions other than what you've closed on hold given where your balance sheet is right now?

Well I think that, as you know it moved up and down a little bit from the high 6%s into the mid 7%s. I think if we projected that out to sort of end of the year after we complete some dispositions that we're talking about, that number is back down into the 7% range roughly. We'd like to keep it under 7%. It will be a little higher than that until we do the dispositions or other funding. But we'd like to keep it in that 7% range.

Okay. And you talked about, if you, maybe projecting five or what, $370 million out on the revolver by the end of the year. How high do you feel comfortable running that balance before you term that out?

That's about where we'd want to be.

Yes.

And, yes. So once -- we want to have, as John mentioned earlier, the capacity to do other things. So --

Sure.

So we're going to do that and once it gets into the $400 million range -- we have the ability to grow that to $700 million. We have a term loan of $150 million that we can grow that to $250 million. So we have plenty of capacity, but we don't want that balance to get too high.

Yes, but remember that's the pending activity takes us to $375 million at the end of the year before proceeds from the sale on industrial portfolio.

Right.

And or any other sales. So all these, there are a lot of component parts moving around for sure.

Sure.

And all of us get together many times during the week, and how are we doing on this and how are we doing on that? But I think with the combination of some reverse exchanges and so forth, that $375 million should be quite a bit lower than that.

Okay. Great. Thanks for the color.

Mitch Germain from JMP Securities.

Hello, good afternoon guys. Tyler just could we just talk about the guidance. I guess it was $0.02 related to acquisition costs, $0.02 for industrial sale, and then what was the other $0.02 for this?

Well, it related to all the other things that we sort of talked about during the quarter. The higher IT costs, the delayed closings of some our acquisitions that we originally forecasted to happen earlier. The list that I provided at that point.

Great. Okay. The mix of all those things. And then you said year-end occupancy 92%, where was that previously?

We had given 92% last quarter as well.

Okay, so it's unchanged. And then the industrial sale you're expecting the entire bulk of it to sell in the fourth quarter?

Absolutely in the numbers, yes.

Great.

As John said, there could be some timing issues there with the 1031s, but in our guidance, it's assumed all to happen in 2012.

Great. Thanks, guys.

Dinesh Artwallah from Barclay's.

Hello guys my questions have been answered. Thank you.

Jamie Feldman from Bank of America Merrill Lynch.

I'm sorry. Just to follow-up on the guidance, so you said the acquisition costs, the additional $0.02 of acquisition costs that was not in prior guidance?

Right. Last quarter we gave $0.02 of acquisition related expense guidance and we ended up having $0.03, and now we have a projection of an additional $0.02 of that, which was not in our prior guidance.

Okay. So then I guess what's throwing me off, is my question before you said same store was 3% now you're at 2%. But you're occupancy is flat at 92%. You do have that -- it sounded like maybe $0.01 from operating expenses. I don't understand the 100 basis point swing in the same store?

Well, we talked about why our expenses were higher. The IT costs are up. So the operating expenses, and as I said, in the second -- in the third quarter, we have flat same store due to the lower occupancy. So that's what, I'm not following.

Okay. Well I guess, so the IT is not a G&A number. It's an NOI number?

It's a combination. There is a lot in G&A but there's some lap over into property management in G&A as well.

Okay. All right. That makes sense, thank you.

At this time there are no other questions. I'd like to turn the call back over to Tyler Rose for your closing remarks.

Thank you for your interest in KRC.

Ladies and gentlemen, this concludes your presentation. You may disconnect and have a good day.