Kilroy Realty Corp (KRC) 2013 Q1 法說會逐字稿

Good day, ladies and gentlemen; welcome to the first-quarter 2013 Kilroy Realty earnings conference call. My name is Philip and I will be your operator for today. At this time all participants are on listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Tyler Rose, Executive Vice President and Chief Financial Officer. Please proceed, sir.

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 in Los Angeles; Heidi Roth, our CAO; 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, Jeff will review conditions in our key markets, I will finish up with the financial highlights and updated earnings guidance for 2013. Then we will be happy to take your questions. John.

Thank you, Tyler. Hello, everyone, and thank you for joining us today. As you all know, we entered 2013 with a large and growing set of operational priorities. Our first-quarter performance demonstrates that we are laser focused on quality execution across our entire operating platform.

In development, construction activity at our four fully pre-leased projects in the San Francisco Bay area remains on schedule and on budget. We expect to deliver the first of these projects in the fourth quarter and we are confident that more development is on the way.

In acquisitions, as we announced on last quarter's call, we closed in January of this year on the acquisition of Westlake Terry, a two building 320,000 square foot office property in the South Lake Union submarket of Seattle. The project has an in-place first-year cap rate of 6.8%. Subsequent to the purchase Microsoft, one of the two large tenants in the building, exercised its option to renew its 94,000 square foot lease through 2019 subject to final documentation.

In leasing we delivered a strong opening quarter signing new or renewing leases on 434,000 square feet of office space at rents that were 11% higher on a cash basis and 16% higher on a GAAP basis than the rents in the expiring leases. We also have about 300,000 square feet of in-place letters of intent.

And on the disposition front we are focused on the sale of nonstrategic assets and nonstrategic land that has been previously held for development. As expected, our first-quarter occupancy dipped to 90.3% as a few large tenants completed scheduled move outs. We have re-leased a large portion of this space and our stabilized portfolio is now 93.4% leased.

All of this activity is taking place within an overall West Coast market environment that continues to gain strength most prominently from technology, media and entertainment oriented industries and all the business services that support them. Technology is reshaping all types of businesses as it is weaving its way into every sector of the economy. Also trade, tourism, construction are now generating additional jobs in our markets.

Two factors related to the emergence of significant tech demand continue to have a real impact on the office market. While we have been discussing them for a few years now they've recently gained more national notoriety.

The first is the trend towards greater densification in a collaborative commercial real estate environment. It is been our experience that the modern work space for knowledge workers is being reshaped not only to accommodate a greater variety of needs but also to accommodate a larger number of employees per square foot.

Business success is now largely driven by the ability to innovate and create ideas, concepts and products that requires that people across an enterprise work together more collaboratively in more efficient space. Companies can lower their overall cost per employee while still paying higher rents to secure the space that meets their physical and locational needs.

The second factor is the rising importance of sustainability in the design and operations of commercial properties. From an owner's perspective a sustainable property delivers more effective operating systems at a lower long-term cost and a more marketable property that appeals to the younger collaborative workforce.

Companies face intense competition to recruit and retain top-quality talent. They want to locate in areas where their employees prefer to live and work; they want locations that are adjacent to transportation hubs and highly amenitized and properties that incorporate leading edge sustainability practices. Our stabilized portfolio, for example, is 32% LEED and 46% ENERGY STAR certified and 100% of our new products will be LEED and energy Star ENERGY STAR.

The modern generation work environment is evolving beyond the 9-to-5 workday as creativity and social issues are fusing the line between work and play and we are seeing these trends now in all industries, not just the tech sector. So in our view a property's ability to support higher densities and its level of sustainability are fundamental factors in how tenants choose real estate today.

These are essential elements in how we create long-term value in our real estate portfolio. And you will see them continue to be reflected in each decision we make -- in our acquisitions, new development and dispositions. With that in mind let me review our recent activity and then I will turn the call over to Jeff.

As I mentioned earlier, we are underway with four development projects in the Bay Area with a total projected investment of approximately $810 million. The four projects are 100% leased and will total 1.4 million square feet. The average projected initial cash yield for these projects is in the low- to mid-7% range.

In most of the markets in which we operate there are very limited options for companies seeking modern quality space of any magnitude. The continuation of improved occupancy rates, increased demand and historically low development starts has created an environment in which we believe plays to KRC's strengths.

Turning to our near-term development pipeline, we continue to make good progress on the entitlements for our 333 Brannan Street project in the Soma submarket of San Francisco and expect to be ready to start construction in the fourth quarter. We will evaluate market conditions at that time for the 170,000 square foot modern brick and timber design building, but our current thinking is to move ahead given strong initial tenant interest. Preliminary project costs are estimated to be approximately $85 million.

At our Columbia Square Project in Hollywood we continue to be very excited about the potential for this $375 million mixed use development project. The market has a very strong positive buzz right now with a sense that Hollywood is in the early innings of a Soma like gentrification.

We have just started work on Phase I, the restoration of 100,000 square feet of historic buildings and, while we continue to evaluate the timing on starting Phases II and III, the new office and residential components, based upon our current view of the market it is likely that we will start construction on the balance of the project this summer.

On the office front we are seeing significant interest from several prominent entertainment users for large amounts of space. On the residential front we are in detailed discussions with a few potential operating partners to develop high-end luxury and extended stay residential units.

In San Diego we continue to see positive signs of an improving market including positive job numbers, positive net absorption for the 14th consecutive quarter and growth in rental rates in selected submarkets. With limited construction activity and growing healthcare, technology, software, et cetera, availability of modern work spaces are limited in markets like Delmar and Sorrento Mesa.

At our One Paseo mixed use development project in Delmar we continue to make progress on entitlement approvals and expect to begin construction next year. We also continue to evaluate Pacific Corporate Center Lot 8 adjacent to Qualcomm's headquarters in Sorrento Mesa for a potential $75 million 175,000 square-foot office development.

Looking at our development program, last year was certainly an extraordinary year in terms of pre-leased development opportunities and this year we are seeing an increase in the number of companies considering new campuses with several large RFPs currently in the market for sizable build to suit requirements both in Northern and Southern California.

Too soon to tell if this makes sense for us, but it confirms our thinking that companies need new, state-of-the-art space to remain competitive and much of the existing office stock is now obsolete or unsuitable to the growing trend to consolidate operations into a collaborative campus-like setting.

Capital recycling remains an important component of our overall financial strategy and we are now in discussions on several smaller sale transactions. We continue to project $150 million of dispositions for the year, not including the potential for $75 million or so of land sales over the next 12 to 18 months. Disposition levels could be quite a bit bigger depending on the ultimate level of our acquisition and development funding needs.

To summarize, 2013 is an important year of execution for KRC across our larger and stronger operating platform and we are highly focused on delivering against all our priorities. And we continue to believe that we are extremely well positioned to take advantage of new opportunities both for this cycle and positioning ourselves for the next cycle given the platform and the team we have built from Seattle to San Diego. With that I will turn the call over to Jeff for a review of our markets. Jeff?

Thanks, John; hello, everyone. The strength of our key West Coast real estate markets has continued to improve over the last three months. San Francisco remains in a class by itself, one of the top performers in the country. Seattle is also performing very well and Southern California is experiencing steady improvement particularly in San Diego. Let's start our market review there.

San Diego continues to experience net new job growth, declining unemployment and positive absorption of available commercial office space. The county had a net increase of 33,000 jobs over the past year and its unemployment rate dipped to 7.7%.

San Diego benefits from limited new supply and a strong concentration of biotechnology, healthcare, telecom and software companies. We expect to see the region continue to improve steadily as the supply of large blocks of space remains limited and larger requirements are more likely to result in new space.

As we discussed last quarter, we've experienced two scheduled San Diego lease expirations totaling 186,000 square feet and now have re-leased 50% of the space. We are 91.4% leased in this market.

Moving north, our Orange County portfolio totals just under 500,000 square feet of office space. Like San Diego, the region's unemployment rate continues to drop reaching 6.3% in March while [net] job numbers have increased by approximately 35,000 over the past 12 months. Net absorption in the market has now been positive for four consecutive quarters; we are 90.9% leased in this market.

Further north the much larger Los Angeles Metro area also continues to add jobs, although more slowly. The region's March unemployment rate declined to 9.9% with the region adding nearly 85,000 jobs over the past year. 40% of the new jobs were in the motion picture and sound recording industries.

At our West Side Media Center campus we had previously announced lease expirations totaling approximately 80,000 square feet. We're making good progress on re-leasing this space and for our overall Los Angeles region we are now at 94.1% leased.

Moving to Northern California, San Francisco continued to outperform most US and global markets with demand driven by the growth of intellectual capital industries. The city's unemployment rate dropped to 5.8% and its net job total grew by 33,000 jobs on a year-over-year basis.

In the Silicon Valley submarkets of Mountain View, Sunnyvale and Menlo Park, where our projects are located, fundamentals remain very strong with continued positive rent growth. Demand for modern generation work environments continues to influence the landscape in this region where proximity to transportation hubs and commercial amenity base are critical elements for success in this region. The Silicon Valley area has a 7.3% unemployment rate of with 29,000 net new jobs created over the last year. We are 95% leased in the Bay Area.

Further north in Greater Seattle our primary submarkets of Bellevue and Lake Union continue to be the best performers in a strong real estate markets. Both markets exhibit a similar level of energy to what we see in San Francisco and Hollywood driven by the educated younger generation workforce.

The Seattle-Tacoma Bellevue Metro area has a current unemployment rate of 5.2% and has added nearly 40,000 net new jobs over the past 12 months. We are currently 95.9% leased in our Seattle properties with concurrent technologies scheduled to take occupancy of 123,000 square feet in Key Center at the end of the second quarter.

As John mentioned, Microsoft has agreed to renew its lease at our Westlake Terry campus. As a point of reference, we had interest from another company take that space before Microsoft exercised its option to renew.

Our remaining companywide 2013 lease expirations total 532,000 square feet. For these expirations we estimate that our rent levels are approximately 5% to 10% below market. Consistent with last quarter, we estimate that current rent levels across our entire stabilized portfolio are roughly at market rates.

That's an update on our markets and I will pass the call to Tyler who will cover our financial results in more detail. Tyler?

Thanks, Jeff. FFO was $0.62 per share in the first quarter, up 11% over the first quarter of 2012 on an adjusted basis. Included in the first quarter of 2013 was approximately $0.01 of acquisition-related expenses. We ended the first quarter with stabilized occupancy at 90.3% versus 92.8% at year end.

As John and Jeff mentioned, occupancy declined in the first quarter as a result of a few previously announced scheduled tenant move outs with more than half of that space now re-leased. At the end of the quarter our stabilized portfolio was 93.4%.

While same-store NOI in the first quarter was down on both a cash and GAAP basis when adjusted for one-time insurance-related payments and property tax refunds in the first quarter of 2012, same-store NOI was up 2.9% on a cash basis and declined 0.6% on a GAAP basis.

As John noted, we completed the acquisition of the Westlake Terry project in South Lake Union in the quarter. The total purchase price was $170 million including the assumption of $84 million in secured debt with an interest rate of 6.05% that matures in 2019. The stabilized cash yield in 6.8%.

In January we issued $300 million of ten-year senior unsecured notes at a rate of 3.8%. We also raised approximately $24 million under our ATM program during the quarter. In February we moved from the S&P small-cap index to the S&P mid-cap index.

Now let's discuss updated guidance for 2013. As always I must remind you that we 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 and a significant shift in the economy or our markets going forward could have a meaningful impact on results in ways not currently reflected in our analysis.

With those caveats our assumptions for 2013 are as follows. We estimate remaining 2013 development spending on our four under construction projects, our redevelopment project and the commencement of Columbia Square and 333 Brannan to be approximately $275 million. That excludes any spending on Redwood Towers since the timing is not yet set and any other potential development activity in San Diego.

As of today we have full availability on our bank line and approximately $85 million of unrestricted cash. We have no debt maturities until late 2014 and, as John said, we are targeting $150 million of dispositions this year plus another $75 million of land sales over the next year or so.

We do not include any incremental acquisitions or acquisition-related expenses in our forecasted numbers and for reference we've been averaging about $0.06 of acquisition-related expenses a year over the past few years.

In terms of occupancy, we are maintaining our year-end projection at the high 92% level with one more quarter at the current level. As usual occupancy projections are subject to potential future acquisitions and dispositions. Taking that all together we are maintaining the midpoint of our previous 2013 FFO guidance and tightening the range a bit to $2.46 to $2.60 per share. That is the latest news from KRC. Now we will be happy to take your questions. Operator?

(Operator Instructions). David Toti, Cantor Fitzgerald.

Just quickly, what are your thoughts on Seattle given that you currently have operating properties there? Are you looking at any land or development opportunities? And if not, what is the rationale for staying out of that particular market?

Staying out of the development side of the market, is that what (multiple speakers)?

Yes, the development side.

Well, we kind of look at everything. Right now development versus where rents are, and rents have gone up around 8% or plus or minus in the last year on average, we have done a little bit better, are forecast to go up about 8% this year. They have got a little while to go before they are going to justify new development.

Now the alternative to that is when you have tenants in tow that need large spaces they've got to pay the current tariff or the current rent in order to have buildings built and we're talking to some of those. We are looking at a couple of sites; we haven't been able to make sense with them yet. But over time I think you will see development -- Kilroy doing development in Seattle, just not yet.

Okay, and then my other question has to do with the 300 plus basis point spread between your current portfolio occupancy and lease rate. What is the flow of commencements through the rest of the year netted against sort of no move outs and is it sort of back half loaded, in your opinion?

Yes, as I said in my comments, I think we will have one more quarter at the current level and then we will be up to the high 92% level by the end of the year. So it is back-end weighted.

Okay, thanks. That is helpful.

Josh Attie, Citibank.

For some of the projects that are on the come, Columbus Square, One Paseo, Pacific Corporate Center 8, can you remind us what level of pre-leasing you would require to get started?

Well, I don't want to get pinned down too much by that. As you know, we have developed over -- historically we have been about 70% pre-leased in our development since 1997. Whether we will stay exactly in that range or not, I don't know.

I can tell you that of -- we currently have about 1.7 million square feet worth of early-stage to a little bit further negotiations or interest in pre-leased development throughout our portfolio and that includes Lot 8 and other properties in San Diego and excluding One Paseo.

That includes the entirety of the office space at Columbia Square, the new office space, not the historical. That includes 333 Brannan, that includes Redwood Towers up in Redwood City. Maybe I missed something there, but I think we will continue to see some fairly strong pre-leasing throughout our development starts.

Can you remind us how large One Paseo could be in dollars?

It's around $700 million with roughly $600 million of new spend.

Is that one that you would do on your own or with a partner?

All options are open. We do the office and the retail, the question is whether we do the three phases totaling about 600 units of resi with a partner or sell that off. We haven't decided yet.

Okay, thanks. And one separate question. I know you mentioned a flat mark to market for the portfolio. But can you update us on what San Diego is on a mark to market basis versus maybe LA, San Francisco and Seattle?

Jeff or Tyler, have you got that?

Yes, I've got that. Well as Jeff said, just from a timing perspective 2013 -- we're between 5% and 10% under market for those expirations. But on a regional basis San Francisco is about 25% under market, Washington is about 11% under market, LA is basically flat and San Diego is about 15% over market.

Okay. Thanks very much.

Jamie Feldman, Bank of America.

I was hoping to get your perspective on the pipeline of supply in San Francisco. I know people are pretty positive on the level of demand and the growth of (inaudible) companies. But it sounds like there is development -- several development pipelines that are ramping up. How are you guys thinking about the competition out there and how do you think the market plays out over the next year or so?

That is to be determined for sure. There is about 2 million square feet of projects that have sort of announced themselves, but some of those haven't started yet and some may not start or may delay their starts. There is (inaudible) Three that is 285,000 square feet that is under construction which we think will get leased -- we know they are dealing with a number of institutions. That's a great building.

There is 535 Mission next to our 100 First, which Boston Properties are doing. I understand they had their call earlier so you probably have their thought on that. There is also 50 Hawthorne which is a small outbuilding to the 680 Folsom building that BXP owns. I understand they are in negotiations with somebody there, at least that is the market scuttlebutt.

So I think all those projects -- they are obviously all going to go, they are underway and I think they will do just fine. And then for 2015 or 2014 -- late 2014/2015 starts you have our 333 Brannan, that is a different building than the high-rises. We are already dealing with a number of tenants that want the entirety of that. That is kind of a six level latest, greatest, state-of-the-art brick and timber building.

You have 222 Second Street which is Tishman-Speyer, that is about 450,000 feet. They say they are going to start, they haven't started yet, but they also say they are looking for a tenant, but you have to talk to them. I don't want to give you my commentary on which buildings I think are going to do real well and which I don't think are going to do well.

2016 you have got 181 Fremont that Jay Paul recently acquired, sort of a combination of mostly condo towers and 400,000 square feet of office. You can imagine, we have looked at most of these properties when they were available earlier and we made our bets where we thought it was an appropriate place to make them. I think that is going to have some challenged office space, frankly.

And then the question is what comes on stream, when does Transbay Tower -- again, you heard the call earlier today, I didn't. So you probably got the information from them and that of course is a big, big building.

As regards to sort of the second part of your question, Jai, what are we doing? I think we are extremely well-positioned. Our cost basis is so low on most of the buildings we are acquired there and we have upgraded them, we are getting -- doing great rents.

We are getting lease terms that generally go well beyond these other buildings would come on stream with some of the tenants that we have that are expiring during the periods that this 2 million square feet could potentially come on stream. We have done extensions and we're doing extensions and so forth.

So I think we are being proactive and I think that we are going to be the recipient of the fresh new rents that these buildings have to have which should impact any rollovers we have or renewals very positively.

Okay, and then just one follow-up. On the disposition plans, can you talk a little bit about pricing and demand for the kind of assets you are looking to sell, maybe where cap rates are?

Sure, this is Eli. We are selling a variety of assets, fewer portfolios this year and more one-off. As far as the cap rates go it depends pretty significantly on the asset. Some of these things will be in the low fives, I think some of them will be as much as the mid-sixes and that is kind of the range. And then obviously we are selling some land and the cap rate on that is zero or there is no income, that is just capital back in.

And then just in terms of market cap rates over the last three months or so, any change?

The market is getting harder, tougher and it kind of feels like it is continuing to build up pressure as the year goes on. And I guess I continue to see that going through the end of the year the way things look right now with capital booked at and equity.

Okay. All right, thank you.

Vance Edelson, Morgan Stanley.

Given that the occupancy is expected to remain around this level for another quarter and be a bit back-end weighted could you provide some color on your current success backfilling the recent expirations? Is that going well?

Yes, this is Jeff. I think I mentioned in my remarks that we had 186,000 square feet, two tenants in San Diego and over 50% of that space is already re-leased and (multiple speakers) high rents. So we are very happy and comfortable with the direction we are going and we've got space in West LA that we got back that we have got a lot of activity on that 80,000 square feet also. So we are feeling really good about where we are and the strength of the market.

Okay, great. And I might have missed it, but could you comment on San Jose and that market's strength or lack thereof relative to some of the surrounding neighborhoods?

Are you asking about San Jose specifically or are you asking about Silicon Valley relative to San Francisco?

San Jose specifically, if you could.

It feels -- it continues to feel weaker. If you talked -- if you think about the attributes that we have noted as being desirable -- close to transportation, having the right physicality, where people want to be, San Jose really isn't in that circle anymore. I think with respect to what we are looking for you won't see us looking there.

As we look at the world we think we will find some -- plenty of -- well, not plenty, but we will find some deals out there in the seams, but we are very focused on the circles and squares, the locations and the physical product. I think there is product that you can buy in Santa Clara and San Jose that may look accretive with a low cost of capital but it is not the kind of stuff that we are going to do.

We are focused on the area from Sunnyvale up through I would say San Mateo on the peninsula where we think the strongest demand will continue to remain because of the factors that John noted and the attributes and the assets that John noted earlier on the call that really are meeting the needs of today's workforce. Does that make sense? Is that answering your question?

Yes, that does. Thanks a lot, that is very helpful.

Brendan Maiorana, Wells Fargo.

Maybe I'm reading a little too much into the positive cash rent spreads in the quarter, but I thought my recollection was last quarter -- maybe it was the quarter before -- that sort of the mark to market for the 2013 roll over was plus 5%. And I think you guys mentioned its plus 5% to plus 10% and you put up a plus 11% in the quarter.

So I guess the question is, has the rent spread outlook gotten better because you are pushing rents or am I just maybe reading a little too much into one quarter's worth of data?

Yes, it may be the latter. But remember, 11% is what we executed during the quarter. Where we are talking about the 5% to 10% was what is expiring, those leases that are expiring. So it's a little bit of a different subset. So I wouldn't get too caught up in those numbers.

But is it -- yes, I mean -- but I thought I remembered you guys saying it was sort of -- it was a little bit lower, but you are pretty comfortable at plus 5% to plus 10% for this year as opposed to -- I thought original guidance was more just at the low end of that range.

Yes, I mean again, there is only 500,000 square feet expiring, so the remaining to expire this year. But we are fairly comfortable in that 5% to 10% range.

And then, Tyler --.

And let me point out, this is John. We are known to push rent, so we are going to push rents to the extent that we can and hopefully we will beat those. I mean right now we think that is good guidance and if we can beat it we will be delighted.

Sure. No, that is helpful. And then this is probably for Tyler also, but I know you guys separated out the tax rebate and the insurance in the same store. But even if I strip that number out it looked like operating expenses on the same store were up fairly significantly year over year. Is that something to be expected going forward or was there something else in the quarter that cause OpEx to be a little bit high versus last year?

No, yes, I think you're right, expenses were up. We actually increased our insurance coverages across the portfolio, so that increased expenses and there are some additional costs associated with running the properties. But I think you are right, the expenses were a little bit higher.

Okay. And then last one, it looked like from a TI perspective, TIs and leasing commissions, that they went down in terms of rent per square foot or TIs per square foot this quarter. Yet still sort of the AFFO or FAD number was a little bit lower and the TI spend in the quarter was high. Going forward should we expect that number to -- the TI spend to go down as we get throughout the year such that FAD numbers probably start to look a little better?

Yes, the first quarter was higher than last quarter obviously and a lot of that had to do with we did so much leasing at the end of the year; we did 3 million square feet of leasing last year. So a lot of that spend is going on for the move ins for like the (inaudible) up in Seattle has a fairly big spend.

But going forward for the remainder of the year it is going to be at that -- roughly at that $14 million level and then it moderates down towards the end of the year. Now it depends again on what leases we sign because we have had this issue over the last several years where we continue to do just a ton of leasing and so that keeps the TI and leasing commission number up. We have less leasing to do now so we anticipate that number will go down as we get towards the end of the year.

Okay, great. Thanks.

David Rodgers, Baird.

Hey, John, early in your comments you talked about LOIs I think subsequent to quarter end. I heard like a 300,000 square foot number. I guess can you verify what the number was and then give us some color on whether that was all operating portfolio or some potential development as well as new and renewal?

All of it is in the operating portfolio. It was around 300,000 that I mentioned, it is a little bit -- a shade over that. We've got quite a bit more we're negotiating right now. What were the other components -- sorry, David -- your question?

New versus renewal.

51% was new and 49% was renewal.

Great. And I guess, John, following up on your comments as well about this collaborative tech space you talked about. And thanks for the color on the LEED certification and ENERGY STAR. But how much of the portfolio today, whether you quantify it in NOI terms or square footage, comes through as this collaborative tech space? And how far are you comfortable pushing that level given the comments that you had earlier?

I think if you don't -- first of all, in terms of the percentage of the portfolio I would say probably, I don't know, 70% or so. That is a guess, but I would say 70% or possibly more. Let me get back to you with a more accurate number.

But in terms of pushing the envelope, if you are talking about is -- it is the trend. Let me tell you something and I have spoken about this in a lot of different industry conversations and panels and whatnot. I think that in office space today that if you are not looking at your portfolio as to how it is going to accommodate the changing needs. And really we've seen the most remarkable transformation in the way office space is being used in my career, and that is 40 years worth, okay.

We are not going back to cubbyholes and private offices, it is just not going to happen. Maybe that will happen with some of the lawyers and some of the financial teams, but basically even with lawyers and financial entities we are seeing it go far more towards the more open environment.

And I think if you have a building that doesn't permit that from a physical standpoint you have a wasting asset. And when we look at acquisitions the first thing we look at is it in the circle of where we want to be, access to transportation, et cetera, et cetera.

And second is it what we call the square, does it have the physicality or can you give it the physicality. If it doesn't have the right bones, if it isn't the kind of building that people want to be and it will be a -- it will become a secondary building.

And I think you are going to see a transformation in this country, particularly in the technology laden Pacific coast where there is going to be absolute preference for buildings that have these characteristics in those locations.

People want to be whether it is in a vertical campus in one building or whether it is any multi-building campus they want to be in an environment where they have collaboration. 70% of the tech company employees are either Gen Y or millennials. If you go against those odds I think you are playing a bad hand.

Great, thanks for that. And then one final question maybe for Eli and Tyler. You talked about dispositions funding future growth really as a function of the investment activity. So what percentage of funding should we think about dispositions being as a percentage of overall outlays? And then how does this change the NOI mix over the next 12 or 24 months?

Well, on a percentage basis, for example this year we have, as I said, $275 million of spend on the development side assuming we don't start anything else. And we are hoping to do $150 million of dispositions. We have our bank line, we have the ATM. So it is always going to be a combination of those sources. And I don't know if we want to be tied into a certain percentage.

But if you look at our history and that chart that we always show which -- where were we in the bubble years? What did we do in terms of acquisitions, development, dispositions? We have always sold property to fund our activities and we are going to continue to do that. And again, as John said earlier, if we decide to do more on the acquisition development front we're going to increase our dispositions.

But you are right though on an NOI basis. On an income basis if you sell too much you are going to have this period of time where you don't have the EBITDA but you do have the cost. And so, we do need to manage that and that is why we will always look at our ATM program and other sources of capital, not just dispositions, to fund the entire growth.

All right, great, thank you.

John Guinee, Stifel.

Nice job, guys. Just a quick few miscellaneous questions. One, is DIRECTV in your dispo plan for this year?

No.

And then number two, just back of the envelope, John, Lake Union looks like about $530 a foot, 6.8 implied cap implies about a $36 net rent. What are people paying $36 for, what kind of physical product, what kind of amenity base do you have for that in Lake Union?

Yes, that number isn't exactly right because it includes parking income as well as some retail space which is above market. So the rents there are closer to the low- to mid-30s and I think that is the generally accepted market rent with respect to what they are paying for in that market.

If you look at the Westlake Terry deal it is right in the middle of things, it is right on the trolley, it has the physicality that is perfect, it has some parking, it as retail, it has great ground level amenities and that is what people are paying for in that market.

If you have all those attributes you can get to that low to mid-30 net rent where you are right now. And that's what we are seeing in terms of the demand that we saw in the -- other conversations that we were having outside of Microsoft.

The Westlake Terry building, John, was about five or six years old. It is one of the best buildings in the entire area, is has public -- the two major public transportation means are at either end, it is an entire block. I mean it's pretty killer space. So we think that was a very good buy and we sort of anticipated that we would be able to either re-lease or renew Microsoft which we did.

As Jeff mentioned in his comments, we had somebody else not quite as good of credit but extraordinarily good credit that wanted the entire -- the entirety of the building and would've paid a higher rate than what I think Microsoft's option was for.

Yes, I mean we certainly think if we had it vacant we would be $35 plus. So --.

And then DIRECTV?

Yes, your comment was is it in our numbers to sell this year? No, because if you think about the guidance we gave, it would blow through that guidance pretty quickly in terms of aggregate dollar amount. We are going to look at DIRECTV, I don't want to get too specific, all of these tenants listen to our calls, but it is not in our numbers for this year.

Okay, thank you.

Craig Mailman, KeyBanc Capital Markets.

I just want to follow up on the dispositions. Can you maybe give us a mix or geographic mix of the 150 and maybe some of the characteristics you are looking for and asset candidates for sale?

I will give you a little bit; I don't want to get pinned down too much on this, but I mean certainly it is going to be Southern California focused and it is going to be some nonstrategic assets and the land. It's probably two to three or so pieces of land in the value range that Tyler has mentioned, it's going to be some smaller assets in and around Orange County and San Diego.

We are working on a pretty significant evaluation of exactly what, when and exactly how we go about that. Small portfolio is bigger, et cetera, et cetera. So it is hard to pin it down exactly. But Southern California waited and a combination of land and smaller buildings and maybe some small sub portfolios.

How much do you guys have out in the market now? I know you talked about a couple of small buildings, but have you started marketing pretty aggressively or is it still too early in the year?

We've got about four things that are what I would call in process, either we have already marketed them or we are close to the end of selling them. They are in the market or we are working with any specific buyer on them. And we have got another handful of things that are pretty close behind that and then we've got another set of things that we might by the next time we have this conference call be ready to kind of tell you what we are going to take to the market in that.

All right, thanks. And then just separately on Columbia Square, the project looked like it got bumped up by about 75,000 square feet and $60 million of value. Could you give a little color there?

Yes, this is David. I can do that. Keep in mind when we bought it -- we have 870,000 square feet of entitlements and we have been working the design and we have been able to add to the square footage to take advantage of that excess entitlement that we have. So we think we have got it kind of set and we have got the right product and the added square footage is going -- added square footage will add additional value.

Great, thanks.

Michael Knott, Green Street Advisors.

John, in the past few years you have created significant value, you and your team, through external growth particularly into San Francisco. You have assembled a solid team. Just curious what -- from here what can you realistically do as an encore to that, particularly in the Bay Area now that the cycle has progressed there to maybe the fifth or sixth inning. Just curious how you think about what you can do as an encore to the great things you have done the past couple years?

I don't know what I -- I'm a pretty good dancer but I don't know how to dance around that one too much, David -- or rather, Michael. I'm very -- if you look at sort of that chart that we show where we were big acquirers in 1997 and 1998 and then not big acquirers until 2010, but through that period we developed quite a bit, at much better returns than people were buying buildings for. And sometimes there was nothing going on because it didn't make sense.

I think for us we are pretty pleased with -- we think the markets come to us with regards to the skill set that we have and the platform that we have with regard to the development side of things.

And when you consider the fact that the development we have underway and the stuff that we are talking about is going to be largely pre-leased, it is going to be state of the market, the best kind of product you can have at the locations that you want to be at because we are not going to -- we are very disciplined, we are not going to move away from those physical and locational characteristics.

And we are bringing those things and in the low to mid sometimes high sevens. Compare that with a lot of the stuff that is out there that is for sale today I would say a lot of the stuff is moving away from our circle of where we want to be and doesn't have the physical characteristics and I went on at length in an earlier question in response on that.

But I do think we are going to continue to see some pretty good acquisition activities. There is a lot more coming in the market from what all the brokers are telling us. We do get a lot of first looks, there are a number of things that we are teeing ourselves up for -- downstream development with very little cost over the next several years, but where we are not having to buy the property and so forth now. I look at those as next cycle.

In terms of this cycle, I think we are going to -- I think you are going to see some pretty powerful development from everything we are feeling. I don't want to get pinned down on that but I did make the comment. We have about 1.7 million square feet worth of early-stage discussions with a multitude of tenants between San Diego and the Bay area that require modern space that like -- were the buildings that we can build.

And I can't say that we are going to get all those for sure, I can't say that we will get any of them for sure. But I can tell you it is a far different situation than it was six months ago or a year ago with the exception of the Bay Area deals that we did.

So I think we are very well positioned, we have the team to execute it, we have very good hand, we are known as straight shooters, we have a very simplified structure. And I think one of the things that helps us beyond having a balance sheet which we are very focused on and maintaining and having the team, but having the properties, the places, the people want to have projects built and then not having the complications of partnerships and all that kind of stuff that some of the private guys have. So I hope that will be an encore, we will see.

Thanks for that. And just to clarify the 1.7 million feet that you mentioned, that would be an entirely listed on page 22 of the supplemental within those projects or are there additional projects that we might see come on to this page that you are referencing that we might see come onto this page in the future?

Is Redwood City on that supplemental?

Yes.

So I think the answer to that question is, yes.

Okay. And then -- thank you for the added submarket disclosure on page 9 of the supplement. One thing that stands out to me is the I- 15 and just the low leased percentage below 80% and it is 6% of your portfolio. And maybe Eli hinted at this a second ago talking about dispositions, but I am just curious. Is this a long-term part of your San Diego presence? And then also is this submarket where most of the above market rents are in your San Diego portfolio?

A little combination of each. Let me break that down. I'm not in love with -- we are not in love with two-story product on the I-15, so you can guess what that means. With regard to -- that market has been disproportionately hit although we do have a lot of tenant interest. But I don't see that as a long-term hold at all. The other point was is that where we have some above market rents, Tyler?

Yes. Some of the above market rent is on I-15, that is right.

Okay, but the other parts of San Diego do also still have some of that above market rent you talked about?

Yes, there are a couple other leases in our portfolio -- in the San Diego portfolio that are also above market.

And then if I can just ask one more for you, Tyler. This might be splitting hairs just a little bit, but wasn't the guidance before for at 93% occupancy at year end? Now it sounds like you are saying high 92%. Maybe I am just recalling it incorrectly? And then if I could just for the high 92% occupancy at year end what is the corresponding percent leased?

Well, in terms of the first question you are splitting hairs a bit because I did say 93%, so you are right. But our number actually was 92 point -- I can't remember what it was -- it was high 92%. So the number actually in our current forecast is actually higher than our previous forecast, but it is probably better to give ranges just for exactly the reason you are asking the question. Because once we say a number you guys jump on it. So the range is in the high 92%'s, it was in the high 92%'s before. And the second part again was --?

Thanks, yes, that is helpful. The second part was just the corresponding percentage leased at the end of the year that goes along with the high 92% occupancy.

Well, I mean it's really -- that is an unknown. We don't really forecast what our leased percentage is because it just depends on how we do during the remainder of the year on what is going on next year. But -- so as we get higher and higher if we get back to 93%-ish, high 92%'s, the leased percentage will probably be closer to that number just because we have less space to lease.

Thank you.

(Operator Instructions). Vincent Chao, Deutsche Bank.

Most of my questions have been answered here, but just going back to Michael's question, original one on the encore. With a lot of the land that you had in San Diego and the Bay area discussion regarding new supply coming on, just wondering what other markets if any other markets that you are looking either on the acquisition side or maybe on the land side to grow inventory?

Well, we are not looking at anything outside of the geographic areas we are in right now. We think there is a lot of money to be made in those markets, they happen to be four of the five best markets in the country. So we are pretty focused -- we are not off flying people to Colorado and North Dakota.

Okay. And just on the development yields, you are talking about low to mid high 7%. If supply does come on to the point where it pressures the returns a little bit, I guess at what point does it not make sense to develop anymore given where interest rates are today and all that kind of stuff?

Well, obviously -- I mean not to be a smart aleck, but when it doesn't make sense we won't be developing hopefully. But I think the thing which we have a particularly good position is we have land parcels where people want to be that fit the characteristics transportationally and the product physically and the environment and so forth where people want to be. And we have -- so controlling that land is good.

Having the expertise -- nobody ever questions us with regard to our development capability. Having the balance sheet is obviously -- is a wonderful thing. And from the standpoint of competitiveness, when you don't have to come in with a -- make a deal subject to a financial commitment or make a deal subject to the approval of your financial partner or your joint venture partner, we eliminate some of the things that most people have to do and that gives us we think a leg up.

I would say that you used the word encore, and I don't know if Michael Knott is still listening, but I think it would be an encore to consume a significant portion of our development land that currently doesn't produce any revenue but it's on the books, it produces a little bit of outflow because of property taxes and so forth and convert that into income producing property. I mean I think that would be pretty spectacular and we are obviously very focused on that.

Okay, thanks. Yes, I was just trying to understand if you would be willing to accept a slightly lower return than the low to mid 7%'s given where interest rates are today and acquisition cap rates are, that's all.

Yes. I don't really want to signal that, we look at a range. I mean the first deal we did up in the Bay Area with [some offices] was about a 6.7% going in pre-lease deal, long-term lease, great tenant, great site. And strategically we looked at that and said, hey, if we do that project we are going to get on the map pretty quickly in the Silicon Valley area as being serious about development.

Obviously with Eli and Mike Sanford and all the other team we have up there that are so well known in those areas we already had a pretty good reputation from a people standpoint. But that project at 6.7% led to a number of the other deals that we did which were considerably better than those yields. So I'm not going to say we won't do a 6.7% or a 6.5%, but we are sort of pretty happy in that sort of mid 7% rate and hopefully that will keep going.

Okay, thanks a lot, guys.

Ladies and gentlemen, this will conclude the question-and-answer session of today's conference. I would now like to turn the conference back over to Tyler Rose for closing remarks.

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

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