Kilroy Realty Corp (KRC) 2014 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first quarter 2014 Kilroy Realty Corporation earnings conference call. My name is Christina and I'll be your conference operator for today. (Operator Instructions) As a reminder, today's event is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Tyler Rose. Tyler is the Executive Vice President and Chief Financial Officer. Please go ahead, Mr. Rose.

Good morning, everyone, and thank you for joining us. On the call with me today are John Kilroy, Jeff Hawken, Eli Khouri, David Simon, Heidi Roth, and Michelle Ngo. 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 on 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 a review of the quarter, Jeff will review conditions in our key markets, and I'll finish up with financial highlights and updated earnings guidance for 2014. Then we'll be happy to take your questions. John?

Thanks, Tyler. Hello everyone and thank you for joining us today. We've had an excellent start to the year and continue to operate in some of the most dynamic markets in the country. The ongoing technology and brainpower evolution continues to generate significant value creation opportunities for our business. Today, we are leveraging our unique platform to take advantage of these opportunities and are more active than ever. We are executing on our existing development program, we are positioning the Company for growth through potential new development opportunities, we are pursuing new acquisitions when they make sense, we are focused on leasing our stabilized portfolio and projects under development, and we continue to complete profitable dispositions.

Our markets remain very strong. In San Francisco as we forecast late last year; leasing activity has significantly increased, a significant percentage of the new supply has been committed, and rents have continued to rise. JLL recently reported that demand for blocks of space exceeding 100,000 square feet continues to outpace supply and the mismatch is projected to continue for at least several more years. In addition, a recent survey reported that 8 in 10 Bay Area tech executives plan to grow their workforces in 2014 with a median growth rate of 50%. And as immigration and tenant growth continue, we are seeing the core of the city expand outwards into areas west of Selma and south into Mission Bay. It was just reported that the Warriors basketball team acquired a 12 acre-site previously owned by Salesforce and plan to build their new basketball stadium there in Mission Bay.

In Seattle, the clustering of tenants into South Lake Union and Bellevue has driven up rents by 25% to 30% since our entry into these two markets a few years ago. Bellevue was just named the second best city in the country for new college graduates. In Hollywood, technology is merging with the entertainment business as there is continued growth in the digital media industry. An entertainment news company just relocated its LA office to Hollywood having signed a 40,000 square foot short-term lease with us for one of the existing buildings at our Academy site. They looked at several submarkets in the area, but decided to locate in Hollywood to take advantage of its large creative workforce. This lease will produce some income for us while we get our mixed-use entitlements at Academy and Square.

We also completed the renovation of our Sunset Media Center in Hollywood in the first quarter and the project is now 94% committed. Rents continue to increase with the latest deals at $390 per square foot per month, a level versus our pro forma of $275 per month that excludes parking. And in San Diego, we are seeing steady demand. Colliers recently reported that San Diego is shifting to a landlords market with low supply and steady job growth setting the stage for a further increase in rents. On the leasing front, we delivered another solid performance in the first quarter. We signed new or renewing leases on approximately 350,000 square feet at rents that were 3% higher on a cash basis and 7% higher on a GAAP basis, they are rents in the expiring leases. We ended the quarter 95.6% leased.

Those figures don't include the 12-year lease we announced in February with the online storage company Dropbox for all 182,000 square feet of our office development at 333 Brannan Street in San Francisco. As I mentioned on our last call, Dropbox is expected to take occupancy in the second half of 2015. Among the larger deals we signed during the quarter was a 77,000 square foot 10-year lease with a gaming company, Riot Games, for one of three buildings at our Westside Media campus on Olympic Boulevard in West LA. Riot Games is projected to take occupancy at the end of the year. And in April, we signed a seven-year renewal with Microsoft at our Overlake campus in Redmond, Washington. This lease was set to expire in 2015. We also have 400,000 square feet plus in in-place letters of intent.

We completed one acquisition during the quarter. We purchased a four-storey 100% LEED Gold-certified life science property located in the heart of the South Lake Union submarket of Seattle, immediately adjacent to our Westlake Terry campus for approximately $106 million. The in-place cap rate was 6%. The property is situated on a half city block and includes a three-level subterranean parking structure with an above market parking ratio. It's an excellent location for both general office and life science companies with neighbors that include Amazon.com, the Bill & Melinda Gates Foundation, and the Fred Hutchinson Cancer Research Center. The acquisition environment remains extremely competitive with pricing at a point where most marketed opportunities don't make sense for us.

Given that, we remain very pleased with the strength of our development franchise and our six projects currently under construction remain on schedule and on budget. They encompass more than 2.5 million square feet and represent a total estimated investment of $1.5 billion. With the Dropbox lease in place, four of the six projects are fully leased. We are scheduled to deliver the LinkedIn campus at the end of this year and the Synopsis campus shortly after that. We are encouraged by the tremendous tenant interest we are seeing in our two unleased current development projects that we commenced construction on late last year. We are in advance negotiations with a number of sizable users. Activity at Columbia Square in Hollywood has accelerated in the past few months as the digital media industry is looking at Hollywood as the new hub.

As we have previously discussed, we will bring on the historical office buildings later this year, the new office component later next year, and the residential tower in 2016. In Redwood City, we are in serious discussions with several prospects for all or a portion of our Crossing/900 project, a superb location with immediate adjacency to Caltrain, abundant amenities, and state-of-the-art quality; all are generating strong interest from a variety of tenants including tech companies and law firms. And as I said earlier, we remain extremely busy uncorking future development opportunities in both Northern and Southern California. Each transaction is difficult and complicated, but with our experience and the power of our franchise, we are confident we will be able to add a number of select value creating projects to our pipeline over the next few quarters.

On the capital recycling front, in addition to the San Diego portfolio sale we closed in January, we just completed the sale of an undeveloped land parcel in Rancho Bernardo, our submarket of San Diego, to an owner-user for approximately $33 million. We continue to evaluate disposition opportunities within our portfolio and remain on track to complete $150 million of sales by the end of the year. Looking ahead, our priorities are clear. As I said at the outset, we continue to focus on value creation through leasing, development, acquisitions, and dispositions. We're off to a great start in 2014 and have made progress in each of these areas. We continue to expand our West Coast franchise, build the value of our portfolio, and enhance our position as the region's premier office landlord.

With that, I'll turn the call over to Jeff for a review of our markets. Jeff?

Thanks, John. Hello everyone. As John noted, economic and real estate fundamentals of all of our West Coast markets continue to improve. Job growth was positive across the board and unemployment continues to trend down. The San Francisco Bay Area remains the undisputed leader of the pack. Its March unemployment rate at 5.1% is 3 percentage points below the average across California. With year-over-year job growth at close to 3%, the region continues to post impressive increases in rental rates and leasing volumes. Let's take a look at each market.

San Francisco got off to a great start this year with a material decrease in availability. In the first quarter, including our Dropbox lease, there were eight leases greater than 90,000 square feet that were signed totaling more than 1 million square feet. Six of these deals represented space expansions led by Twitter, Dropbox, and Practice Fusion. In the valley, lease in our Menlo Park property has really strengthened and we are now at 98% committed. Currently, we are 96.2% leased in the Bay Area. Seattle was also performing well. The Seattle-Tacoma-Bellevue region had a March unemployment rate of 5.4% and has added over 40,000 jobs over the last 12 months. In our primary submarkets of Bellevue and Lake Union, class A direct vacancy rates declined to 6.4% and 4.5% respectively and rents have continued to increase.

Rents at our Key Center office tower in Seattle's Bellevue submarket have risen more than 30% in three years since we purchased the property. Also at Key Center in April, we terminated a 45,000 square foot lease in order to release a space at a rent that's three times higher. The new tenant's projected to take occupancy in the fourth quarter. We are currently 98% leased in our Seattle properties. In San Diego, our coastal submarkets are steadily improving as business activity and employment expands and new office supply remains limited. Jobs grew 2.5% year-over-year, higher than any market on the West Coast and 1% higher than the state, driving the unemployment rate down to 6.9%. Del Mar and Sorrento Mesa class A direct vacancy rates are 6.4% and 6.7% respectively. Our San Diego portfolio is currently 93.6% leased.

The large and varied Los Angeles market continues to produce mixed results. Overall class A direct vacancy is 15.7% and the region's unemployment rate is 8.7%. The entertainment, new media, and advertising industries continue to drive growth on the Westside and Hollywood. As John mentioned, we signed a 77,000 square foot 10-year lease with Riot Games for the third building in Westside Media Center. We will recognize an approximately 40% increase in cash rents compared to the prior rent level. Across our Los Angeles portfolio, we are now 96.5% leased. In terms of portfolio rents, we estimate that our rents are approximately 5% below market as a whole and for 2014 and 2015, they are 4% and 5% under market respectively.

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

Thanks, Jeff. FFO was $0.66 per share in the first quarter. This includes approximately $0.015 for a lease termination fee offset by about $0.01 of non-recurring legal expenses. The lease termination fee relates to a tenant in San Diego that notified us in the first quarter of its decision to exercise its termination option on 79,000 square feet effective at the end of the third quarter. The fee will be paid in the third quarter, but under GAAP will be amortized evenly over the first three quarters. We ended the quarter with stabilized occupancy at 92.4%, down from 93.4% at year-end and up from 90.3% a year ago. Our first quarter same-store NOI was up 9.3% on a cash basis and 4.8% on a GAAP basis after adjusting for the lease termination and legal expense.

The solid same-store NOI results reflect higher rents across the portfolio in Bellevue, Del Mar, San Franscisco, and Los Angeles. After funding the 401 Terry acquisition, we currently have approximately $50 million of cash and full availability under our $500 million bank line. We did not utilize our ATM in the first quarter and have just launched a bank line renewal process in which we hope to lower pricing and extend term. As John mentioned, we sold a San Diego land parcel in April for about $33 million. The net book gain on the sale was about $0.04 per share, which given that it is land and not an operating asset, will run through FFO in the second quarter.

Now, let's discuss updated guidance for 2014. To begin, let me 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 guidance reflects information and market intelligence as we know it today. Any significant shifts in the economy or market pent-up demand, construction costs, and new office supply going forward could have a meaningful impact on our results in ways not currently reflected in our analysis. With those caveats, our updated assumptions for 2014 are as follows. We expect our occupancy to remain steady through the middle of the year and then pop back up to the 93% range by the end of the year.

As Jeff mentioned, in the second quarter we will receive another lease termination payment related to a lease in our Key Centre property. This will increase FFO in the second quarter by about $0.01. As always, we don't forecast any potential acquisitions or acquisition related expenses. Our projected remaining 2014 development spending for our current construction projects is approximately $350 million. As John said, our current guidance for 2014 capital recycling is $150 million although this could change significantly depending on market conditions and the emergence of potential new growth opportunities. And we continue to project an FAD payout ratio of 92% for the year.

So to sum up, last quarter's FFO per share guidance range was $2.55 to $2.75. We are increasing the midpoint by $0.08 per share; $0.04 from the second quarter sale of the San Diego land parcel, $0.02 from the 401 Terry acquisition, and $0.02 related to all the ins and outs of the core results, lease termination fee, and acquisition and legal expenses. Taking that all together and tightening the range a bit, we get to an updated 2014 FFO guidance of $2.66 per share to $2.80 per share.

That's the latest news from KRC. Now, we'll be happy to take your questions. Operator?

(Operator Instructions) Craig Mailman, KeyBanc Capital Markets.

Tyler, just on the lease term fees that's going to be hit in 3Q, is there any amortization effect in 2Q and 3Q?

Yes. So, it'll be evenly amortized over the first three quarters so it's roughly $0.015 net in the first quarter, second quarter, and third quarter; and then it's paid in the third quarter. And then we're estimating that the space will be vacant for the fourth quarter so that will offset some of the benefits of the lease termination fee.

Okay. That's helpful. Then on Columbia Square, it sounds like the activity is good there. Just curious, are asking rents going to hold relative to pro forma or are you guys going to get some upside to that? Just curious where rents are on that project.

David, you want to take that?

Yes, I'll take that. The market as we've definitely seen an increase in activity and our project has been showing well and right now, we think we're going to do well on the rents. I would say pro forma rents will be achieved and we'll see how things play out going forward. But activity is strong and we anticipate doing pretty well on the leasing that we do there.

Okay. And then just the last one. Can you guys talk about the opportunity on the most recent Seattle acquisition there given that you're not going to be able to up rents for a couple of years? Was it just a 10-31 transaction or talk to anything that you guys see longer term?

We see a lot there longer term. You have to understand that this is a very modern over standard building built in 2007 that's right on the 50 yard line there. There's some important details about it. Number one is in terms of the price per square foot, actually the [Bulmer] square footage is correct under a release scenario is significantly higher than what the current lease is so when we roll it out, the price per foot is down closer to $700 a foot. And then when you look at the over standard components of this, it's got over standard parking, a subterranean that's worth probably $30 to $40 a foot in the base building, it's got very high floor to floor, above standard floor loading, above standard HVAC and electric pass capacity systems and roof loading systems. And all of those things translate into a) higher replacement costs and b) into usable things the tenants will pay up for rent.

The rent in the building is significantly under market or notably under market in the biotech market, which is up 1% to 2%. The improvements inside the building that aren't in the base building, which are the biotech improvements, are very high quality, very reusable, super separated air systems, and everything is very, very thoughtfully done in a biotech market that's 1% to 2% and then the lease itself has significant increases over the remaining term. So, we think there's a lot of opportunity for this kind of building with this much over standard that will garner higher rents in the long term and with good ups in the lease the way that it is. So, that's the picture there.

Great. Thank you.

And the last thing I would note just quickly is that when I said it's on the 50 yard line, it was apparent in what I meant that it's right on the main transportation lines, it's the best pedestrian environment, it's everything that we've talked about that epitomizes our circle; transportation amenities, nearby housing, and all of those things. So, that's what I was referring to as being the 50 yard line. It truly is in South Lake Union.

And did you guys 10-31 the San Diego proceeds into it?

Some of them, yes.

We had several different deals. We did the San Diego portfolio.

David Toti, Cantor Fitzgerald.

Just quickly, I'm trying to gauge the sort of frothiness of the market in the Bay Area and your continued interest in land and development and in particular, there was a parcel that traded recently for $50 million to Alexandria, 500 Townsend, and the implied cost there on an SAR 6 was about $170 a square foot and we understand that the bidding was pretty competitive. Did you guys have interest in that parcel and does that land price [pencil] for you guys in this market?

David, this is John speaking. I'm going to let Eli talk about a little bit of that. But we did look at it, we did bid on it, it got way out beyond what we thought it was worth. It is a site that's well located next to Caltrain, it is not proximate to BART. It's a pre-industrial area, I'm sure the building will do well, but it was priced beyond what we would have paid for at that location.

So, you view $170 a square foot as too high a point for development working even in that market?

Not necessarily because when you look at cost; you have to look at what fees are in addition to land cost, you have to look at what your entitlement risk is if at all, how long it's going to take you to get entitlement therefore your carry. But then we also look at just like anything else, just like a residential neighborhood, there are certain streets that are the very best and as you get further out from that, they become not as best. I mean they become good and then they become less good and I would say this one is a good location, but without a lot of great amenities on the street. They'll come in due course I guess. It has great access to Caltrain, which is a definite advantage. So when we talk about $170, $170 for something that you don't know if you can get entitled and that's not the case here, and it's going to take a long time to get entitled and now you have a lot of extraction such as your cost might be $200 or $220 or something, it's different than $170 when you can pull the trigger right away. So, that's the best I can do to help you with that.

Okay. And then obviously you remain interested in that market, but is it your sense that given where land prices are and the sort of delivery timing at this point in the cycle that there's not enough available product for you given what you want to deliver. Are we seeing sort of the tail end of really the supply delivery in that market?

I don't think we're seeing the tail end. What you're seeing is there's a lot of folks that are working on sites to entitle them for some time two, three, four, five years hence; who knows what the cycle will be at that time. As you can imagine, we look at everything and we've said before, we have some long range things we're working on, in the mid-term range we're working on. I'm not going to get into specifics because it's a very competitive world, but let's just say that we think we're going to be able to develop more product in the market that's exactly the kind of product that people want, the exact locations they want. So, it's hard to produce stock, but it's not impossible.

Okay. That's helpful. My final question and forgive if I missed this. Did you talk about the 7.4% increase in same-store and was that primarily tax based?

No. When we say tax based, it was really driven by rent growth in several of our buildings across the portfolio.

On the expense side?

On the expense side. I mean expenses, it comes from utilities, a little bit on insurance, a little bit on RM. It's sort of a mixed bag of higher expenses.

Okay. Thanks for the help.

Jamie Feldman, Bank of America Merrill Lynch.

I guess just following up on that last question. So were those more one-time in nature or do you think margins are now going to be lower going forward?

Well, no. I mean I don't think our margins are different. I mean we had higher occupancy in certain properties that generated higher revenues and associated with that are higher expenses, but then we also had higher tenant reimbursement. So all together, the same-store results were pretty good even with those higher expenses. Our margins are still in that 70% range so we're not expecting a change in margins.

Okay. And then I guess speaking about core operations, can you talk a little bit more about the assumptions behind your new guidance range? Any change to your same-store outlook or year-end occupancy or leasing spreads?

I mean on occupancy, we said we still think we'll be in that 93%-ish range, maybe a little bit better. On same-store, we had a guidance of 3.5% last quarter. We might do a little bit better than that, but I think for now we're happy keeping it at that level. That's a cash number. We have some pre-rent coming in really in the second half of the year on the DIRECTV leases, that will put a little bit on same-store on the cash side. So those are the general assumptions, we're not really changing those general assumptions.

Okay. And then what are your thoughts on the current portfolio mark to market?

Well, as Jeff said in his comments, we're 5% below on a portfolio basis and then if you go through the various markets; we're 26% in San Franscisco, we're 12% in Washington, we're flat in Los Angeles, and we're still about 10% above market in San Diego.

Okay. And then last question. The Riot Games lease, can you talk a little bit about how long you've been working on that or is this a lease that came on pretty quickly? And is LA becoming a little bit more like San Francisco where demand is popping up quickly and taking down space pretty quickly?

This is Jeff. The Riot Games, we've actually been talking about it at the end of last year and we just consummated the deal just recently. So, we've been talking about it for several months.

Okay. And then in terms of those types of tenants like how would you characterize the depth of demand right now from tech media in LA and how it's changed since last quarter?

I think it's strong. You'll continue to see the entertainment media companies come to the West markets; Santa Monica, Hollywood; so I think it's indicative of how strong these markets are. Riot Games did the deal across the street from us originally, they needed more space, they actually put the studio in our building. That studio's being relocated out to Manheim Beach. So, I think again the entertainment media is definitely picking up, it's definitely strong in the West markets.

Further to that, Jamie, there are a number of very big media or rather technology companies that are headquartered amongst other places up here in the Bay Area that are looking at some big requirements down in LA. And the way I like to describe this is the intersection of technology, media, entertainment, social networking, all this stuff. It's like a basket, all interwoven and it's all expanding and growing and the need for content, et cetera. So, it's quite logical and kind of what we predicted some time ago that we'll see more and more of the technology companies get a bigger foothold down in LA and that's what we think is going to happen and we're beginning to see that.

Do you have a sense of the types of jobs in San Francisco -- for these companies the types of jobs in San Francisco versus LA versus even New York or Seattle?

What do you mean the types of jobs?

It's like what are they doing in these different cities? You say like the big companies got exposure in all four?

I can talk with some more friends that have much more authority and understanding of this. But the way I understand it is what's technology, what's media. All this stuff is everybody is looking for content to put through all these devices. There's engineers in both areas; obviously down in the Hollywood area you have a lot more of the entertainment, media, artistic sort of folks. But I'm a little reluctant to just wander on here because I'm not an expert in this and there are so many people that are. So, maybe what we ought to do, Tyler, is put together a little [treatus] or Eli and put it on our link.

I think there's one general comment you can make, which is that the things that they're doing are exactly the same and they're just going to different markets for access to the employees because there's a lot of competition and they feel like for example Facebook having a location here and a location in Seattle. They are doing almost the same thing in both of those markets, but they want to have the broadest draw and you see them going to even other markets and New York to just get a very broad draw on the overall talent because not every bit of tech talent or innovative talent is going to locate in just one market. So, that's part of it. And then, as John said, we'll get back to the other level of granularity on that and get back to you.

Okay. That would be great. Thank you.

(inaudible), Wells Fargo.

I wanted to dig a little deeper into the leasing market in the Valley. There's obviously been great demand in San Francisco for the past few years so do you think that's taken away some leasing velocity in the Valley and what do you expect for those markets going forward?

This is John speaking. About 70% of the new product that's under construction by developers in the Valley is pre-leased. We are seeing some companies with some very, very significant requirements for new facilities from sort of Santa Clara up towards San Francisco all through the Peninsula. It's hard to get good sites in the areas or the circles where people really want to be, which is close to transportation. Many of these cities have very strong I guess you call them anti-growth or growth restricted views towards things. We are working on a number of sites right now. It's true that we've seen a lot of the companies establish either a beachhead and then increase their presence in San Francisco. And one of the things we've been talking about for the last five years is people or rather companies are going to where their people want to live and there's a lot of folks that bus down to Silicon Valley and the Peninsula from the city and not surprisingly, these companies got on to the fact that hey, why don't we locate things in San Francisco.

I think we're going to continue to see big growth in San Francisco, but I don't know that it will be at the expense of the Valley or the Peninsula because the folks are growing down there as well. I think the areas that we look for, those we call our circle, are those that are urban or [urbanisk] in character and by urbanisk, it can be San Diego or it can be Mountain View or areas like that where people really want to be and the kind of things and amenities and living and so forth that people want. If you are out in more suburban like areas throughout the Valley, I think you're not at main and main, you're not at the 50 yard line as Eli likes to point out. I don't know whether you want to add anything to that, Eli.

Yes. And I think the other thing you have to remember about the Valley is the hardware guys are really committed to being down there. If you look who's expanding down there; you've got Samsung, you've got Cisco, Arista, Qualcomm, I could reel off another five or six people who are in active expansion mode. And they're almost entirely focused on Silicon Valley because of where their employees live and because of the collaboration and the clustering of those companies that work with each other down there. And you haven't seen that dimension of a move up into San Francisco with the exception of Riverbed Technology who was founded up here, I mean the founder lives up here. So, there is that aspect that I think continues to drive demand particularly in the kind of traditional Sunnyvale area. And you looked at our tenant audience and Mountain View, they are a chip company, they also have intellectual property as well; but being down in that part of the Valley is very important for a lot of these hardware guys.

If you look at our Redwood City project, our Crossing/900, I mean it's in a nice little town that has all the amenities and restaurants and housing options and more housing options coming and a great environment and the bullet train station right next door and so forth and I wish we had three of those projects here right now.

That's really helpful. And I guess just to follow-up on that. Does the recent LinkedIn deal at 222 Second Street have any bearing on your 555 Mathilda project? Will LinkedIn be subleasing any of that space or operating both properties?

We've talked with LinkedIn and they have grown here in San Francisco. As you know, they had a big fairly significant presence I think maybe 100,000 feet or something and they've taken all of 222 Second Street, which is being developed by Tishman Speyer and that's 400,000 feet or thereabout. So, that was locationally where they really want to be in the city. We've talked with them extensively. They are doing a space planning and so forth and tenant improvements in one building, they're planning on the others, but they said they always intended to phase in over time. Our leases there are, I don't know, 12, 13, 14 years, whatever they are and whether they occupy all of it, do they sublease some of it, we don't know. They say right now they are intending to do what they always intended, which is to phase in to it over time.

But just to put it in perspective, we have a long lease there and if you think about the passage of time, which is maybe 16 months since did that deal, the rents are up about 15% or greater on a triple-net basis in that market. So, we're pretty comfortable with that asset and I think we're going to continue to see companies that make decisions; hey, we're going to grow here and then we're going to also grow here. LinkedIn is growing worldwide. That's what we find with most of these companies, they're growing worldwide and they may take a group that they intended to have in one building or in one campus and all of a sudden put it in India or put it in New York or whatever and then they backfill in with something else. So, that's kind of what we feel is happening, more to come.

Great. Thanks a lot.

Vance Edelson, Morgan Stanley.

The latest news on Transbay, the signing of a large tenant, and the confirmation that they're moving forward with the building; does that change your views either positively or negatively or not at all on the San Fran office market over the next few years?

I think it's an absolute positive and the rents they're getting in that building are high. They have to be high with their cost structure and so forth. We're great believers that you want high tides; whether you're at the 50 yard line or whether you're at the 10 yard line, high tides help everybody. And if you think back to, I don't know, two, three, four quarters ago, there was a number of folks on calls like this that were asking hey, could we end up with a surplus of space being delivered into the market and could that deteriorate rents and so forth. In other words, was the demand there? I think that's been resoundingly answered by the amount of activity that we had in the fourth quarter last year and so far year to date. I can tell you that we're dealing with a number of companies that are looking for well above 100,000 square feet for a couple of years out. I think the market has two or three years at least of good runway. Now, I always had my caveat that as everybody knows, I have no faith in the people in Washington irrespective of which party so I always get a little concerned about them ending the party. What we're seeing right now is very strong demand and continued demand here in the city.

Okay. That's fair. And then back on South Lake Union, is that essentially a fixed split between office and life sciences such that if you ever wanted to move more in one direction with the building, it would take considerable effort or is there some flexibility there?

It's very flexible. We expect to likely continue to operate it as a life science. Frankly, we expect that the tenants that are there are going to like it at the end of the lease term. But when we bought the building, we explicitly ran every scenario including converting it entirely to a hi-tech office, just standard office used for a technology company. It doesn't need more improvements to remain as biotech improvement so if we continue that use, I would expect that we'd have a pretty low CapEx experience and if we convert it to office, there'd be a moderate CapEx experience because we'd really just be taking out some labs and replacing them with open space. So I don't think we see a terrible CapEx issue or question in either of those locations, but given the life science market and demand up there and the superior quality of this building and its location, I'd bet more towards continued biotech use if I'd have to make a bet today. We ran all those.

We ran all those.

Alright, great. And then last one from me. Could you provide a quick cap rate update just directionally up and down the coast and how this factors into your thinking on acquisitions? Overall, would you say it's even more difficult to find anything attractive right now than it was just three to six months ago?

I'd just kind of maybe quickly review our history. I mean in 2010 and 2011, we did $700 million a year while those markets were attractive. In 2012, we thought it was going to be very difficult, but we managed to do another $700 million of really attractive stuff. In 2013, we weren't sure if we could do anything, we ended up with land at $350 million. And so far this year, we've done the one deal that we just talked about it, about $160 million. Can we do more this year? I really can't say. I mean we look at everything that's on the market, it is getting harder and harder and I think we'll probably find a thing or two along the way, but not very much because it continues to get harder. I think it's about as hard in the last three months and it's gets harder now, it's just very, very hard. Cap rate wise you can be all over the board.

I would tell you on a IRR basis what people are looking at and on a core basis, it's a low 6% and that's too low for us. We are not doing those deals and those things could start at a 4%, they could start at a 5% with no growth, they could start at a 2% where people are presuming a lot of growth. So in terms of a cap rate basis, it's really kind of hard to compare an apple and a orange. But on the IRR basis, we're seeing from time to time right outside of the core strike zone, every once in a while there's a little plum that we can pick that has better returns, more upside, something that was neglected, something the market didn't quite see and we'll continue to look at every one of those. Our hit ratio is probably 25 to 1 versus 2012 when it was probably 10 to 1 or 8 to 1.

Okay. That's helpful. Thank you.

Ross Nussbaum, UBS.

Two different kinds of questions. First on the Riot Games lease, I'm just curious how did you guys get comfortable with the credit, that's sort of a one-product company, and is there majority equity owner guaranteeing the lease or not?

We spent time reviewing the credit and meeting with the company and doing our normal due diligence. They're a private company that does extremely well and they've had their game and it's the most popular game in the world currently and games do run their course. But our sense of their credit is very, very strong at this point. And in addition to that, we got a letter of credit that we're comfortable with.

But there's no overriding corporate guarantee from Tencent Holdings?

No.

The second question is on the development side down in San Diego, John, maybe this one's for you. Can you give us an update on where you are in the approval process at One Paseo and then just give us an update on what you're thinking of tenant base on it?

One Paseo of course for those who don't know is the big mixed-use project in Del Mar. We had the bad fortune of having an idiot that was the mayor that was basically a hold-up artist and took everything sideways. Kevin Faulconer was elected here a few months ago; he's a very good mayor, very pro-growth and so forth. The project is back on stream. It will go through what they call the Community Development Group, which is a non-official thing, but you've got to go through that first, that will happen here this spring. And then we expect to go through the Planning Commission mid-summer and then late summer, early fall through the City Council and we expect to get approval for the project.

We've made a lot of adjustments over the course of the last year that we think have been appealing. Our sense is we've gotten Caltrans to come out and say that -- they will not say they support something, they'll come out and say if they're against something and they've come out and said that they think it works fine. So, we're pretty pleased with where we're headed right now and our anticipation is we'll get it approved by the end of the year. And then in terms of the marketability, in terms of where rents are, and so forth; the current market rentals for office space that have nowhere near the environment that the office space will have at One Paseo are under 10% different than what we had forecasted. So, the market's come to us with regard to rental rates on office buildings.

The apartments are totally going to be a slam dunk and the retail's all leased. So, it's first get approval and then build it. With regard to whether we could be interrupted again. In California, as I've mentioned on previous calls, there's something called CEQA. If somebody can file a CEQA challenge, then it would go to court. We have a guy across the street that is trying to be anti-competitive and we are dealing with him and if he files a lawsuit, we think we'd win and it could take three to six months. So, that's where that project is at. But what I'm very pleased with is we now have a city that's back on track and we look like we've got a green light ahead of us and the market's come to us on rents and so forth and demand. Rents in the Del Mar market, Jeff, are up what percent this year? 20%?

Yes, like 22% year-over-year in Del Mar.

So, we think that continues because there is just no good quality product. All the vacancies are kind of old or buildings of 5,000 square feet and 10,000 square feet in the old 1980, 1990 style buildings. In terms of Santa Fe Summit, that's the property where we did the first phase with Intuit. We are entitled for 600,000 square feet plus between Phase II and III. That's on the 56 Freeway between the 5 and 15, just a stone's throw from Del Mar. We're dealing with somebody on both those phases right now, more to come. But I think with the way the market's going, we would anticipate that we're going to see some action on that sometime in the next year or so. And then adjacent to the One Paseo project where we bought the Heights of Del Mar for $100 million and some. Eli, you recall Heights of Del Mar?

$128 million for the (multiple speakers).

$128 million, thank you. That's where we have the land, site, and we're going to build the building there that's about $45 million or so. We're dealing with a law firm for all of that. So, we anticipate starting that sometime this summer I think it is, maybe it's fall. And basically what we're seeing in San Diego is most everything we've got with a few exceptions like Carlsbad is in discussions with folks. So, we're encouraged by what the brokers are saying and I've referenced the Colliers report that Jeff mentioned and the activity that we're seeing. By no means is it robust like San Francisco. If anybody compares anything to San Francisco, maybe it's in the Dakotas or something where there's the oil folks, but it's kind of unfair to compare anything to San Francisco at this point.

Thanks, John.

Michael Knott, Green Street Advisors.

John, just to touch on that a little bit more on the development side. I was just trying to put in context a little bit. Earlier on the call, you mentioned several opportunities that you are working on and hopeful about and then you just touched on some in San Diego. But I was going to ask as some of these bigger projects currently under construction roll off your development pipeline in the next several quarters and they get delivered, do you feel like your overall development pipeline will shrink as that happens or will some of these other opportunities be large enough to offset that and that your overall development will remain as high as it is today?

I think what I've said in the past is it feels like the $1.5 billion at any one time is kind of what we sort of see, but it never works exactly like that. You can end up with a $1.5 billion as LinkedIn and Synopsis will allow. That rolls out $500 million plus or so. We don't necessarily start something the day those finish. But looking over a three-year period, I'd see again we're being very judicial here and very sober, I can see based upon what we're working on and of course the big unknown is when we start One Paseo, but I could see us starting over the next three years another $2 billion to $3 billion worth of stuff, most of which would be substantially pre-leased and a substantial portion would be in this area meaning the Bay Area.

Okay. That's helpful, thanks. And then just a quick one on One Paseo. It sounds like you would be prepared to go spec on the office there just given the strength, but maybe you wouldn't even have to given that you're not facing that decision yet?

We don't have to face that decision yet. One of the things that I like about our position now and I didn't like so much a few years ago is that the market's coming to us both with regard to increased demand, decreased supply, and rental rates where they need to be. The retail takes care of itself, I think the apartments take care of themselves, and then on the office we're sort of in the 450,000 square foot range. My first love would be to have a significant pre-lease on one of those buildings and I think we have a very good chance of that based upon some of the discussions we're having. One of the dilemmas we have is that we can't tell people when we're going to start when we're going to finish, we just don't know yet and it's really hard to market. And fortunately at this point with the market improving, that's working for us we think, more to come.

Okay. Would it be possible demand for that would cannibalize Santa Fe Summit or vice versa?

I don't know that. I don't think the people that would go at One Paseo would necessarily be the candidates for Santa Fe Summit. Santa Fe Summit is going to be a campus or two, it could be multi-tenant, but fairly big multi-tenants in increments of 100,000 plus or minus. (inaudible) likely to be a couple of big campuses whereas One Paseo, I think what will likely happen is one building will get occupied by a big law firm or a big fire category company and the other one will be occupied by several. That's kind of in the area where law firms, accountancy firms, wealth management firms, want to be as well as others. I don't know that -- we may not end up with a check type company in that building. I just don't know.

Okay. And then a question on San Francisco both fundamentals and your investment strategy. One, on the fundamental side, you've talked about not enough supply relative to the demand and the possibility of a rent spike and I'm just curious how that the unique feature in that market of Prop N plays into your thought process and where that stands in the market today?

I don't have the Prop N stuff before me right now. Mike Stanford kind of is the keeper of all out and there's plenty of capacity. If you don't know, Prop N was something that was passed in the city sometime ago and it lets you build a couple of million square feet a year and then if you don't use it and if it's not used in the city, then it accumulates. And so the question becomes at what point does development outstrip that after it has been accumulated and that is allocated each year. We think there's several years for that. The stuff we're working on we think it's much earlier in queue than some other stuff that's being thought of by others. So, obviously we have our head wrapped around that.

One of the projects that could have gone forward more quickly because it had been entitled was the Salesforce land over in Mission Bay where they had intended to build it upwards of 2 million square feet. Of course, they decided not to do that before with Urban Campus and that project is now going to become the stadium for the Warriors. And I might point out that the forces that were anti-Warriors over on the parcel that was close to the Giants stadium have come out in favor of the Warriors being on the previously announced Salesforce land in Mission Bay. So, these things are moving around, Michael; but at this point, I don't see anything we're working on at risk. Obviously, we would hate to buy something and not be able to get it entitled because we're at a queue because of Prop N.

Okay. But you don't see a lack of supply stemming from that that would contribute to rent spike?

Well, there could be in the due course, I don't think that's imminent. But where I see a rent spike coming from continuous spikes is the fact that -- and let me point out that if you are 20,000 foot user or 10,000 foot user unless you are really dying to be in some of the hotter buildings, you have lots of options in the city. You can go over north of market and you'd find space all day long in dozens of locations. If you're a company that wants to be in that sort of the hottest only area and you have a larger requirement, you have almost no choices and that is a recipe for rental increases and we're seeing that in our properties as we have leases come up for renewal as a case in point. Here at 100 First Street, we got a full floor that we were getting back and we had two tenants in the building that were vying for that space and order of magnitude, don't hold me to the exact dollar amount, and we've signed that lease now. But in the course of a week or two, that property was bid up $10, $15 per square foot. I like that.

Okay. Thanks. And last one from me and I'll get back in the queue. I was going to ask in San Francisco given where pricing is for assets and given the $2 billion to $3 billion of development that you cited over maybe in the next few years, would you consider taking any chips off the table to recycle into development?

Well, we've always been recyclers and we look at our portfolio in terms of what are -- Eli and his team are constantly looking at. First, will we get rid of it because we think it doesn't comport with where tenants really want to be and the kind of space or location where they really want to be such that it becomes more commodity and less highly sought after. We've sold a lot of that stuff, we'll continue to do that. We'll do that with our land parcels as well with regard to some of the land we have on the books, particularly some of the smaller ones. With regard to properties that are largely occupied, we look very deeply at where the in-place rents are and where the rents are likely to go or where current markets are and how much value we can reap by repositioning those assets.

And then there are the ones that are the big bombers that we have up and down the West Coast that are leased to big credit tenants and those could become candidates. As you know, there's some Safe Harbor rules and so forth. But we're looking at this and I think you'll see Kilroy -- we said at the beginning of the year, we're going to do $150 million or thereabouts for this year. We said that last year; we did, Eli, $400 million plus. Can we do that this year? Do we sell more next year? I don't know, but we have no mother fixation about any asset and we're going to continue to do be capital recyclers when we think it's appropriate to do so and certainly (inaudible).

Thanks. I'll get back in the queue.

Emmanuel Korchman, Citigroup.

If we look at the Riot lease, there was some news late last year that they were looking to go into HPP's building in LA in a bigger amount of space. Is that lease with you incremental of that or have they decided to take less space and go with your building?

Jeff, do you want to take that?

Yes, it's expansion. The space they took across the street was like 284,000 feet and they took our building as expansion of 77,000 square feet.

Perfect. And then have you guys given any additional thought to taking your sort of development model into other markets outside of the West Coast?

I'll answer that. We have a lot of clients who would like us to. We haven't made any -- our choice has not been not to at this point. We'll always keep our options open, but I can tell you at this point that we're not looking at developing something outside of our West Coast markets, but we've had a lot of opportunities and some in big scale. So, we've been very focused. As you know, we've increased the size of our asset base significantly, we've increased the development activity significantly, we've increased the geographic platform significantly, we've increased our people significantly, and we've done it with I think a lot of forethought. I give a lot of credit to Jeff and Tyler and Eli and David Simon and a number of other people who have worked so hard just to smarten our development sites. We've been focused on there's a lot of fruit to be picked in the markets in which we currently operate where we have strong representation and where we have a great culture. Can we transport that? Should we transport it? Those are questions that we ask ourselves, but they're not on the table for a decision right now other than the focus on our current markets.

Is there a specific trigger that you're looking for to just sort of make that step or is it really just a progression of the Company?

Well, I'm not going to say we're going to be other than the West Coast. But if we go into another market whether it's on the West Coast or somewhere else, we have to do it just like we did in San Francisco and like we've done in Seattle and that is we have very strong, very knowledgeable talent and where we can deliver something that's special and unique and where we think we can build a better mousetrap. We think there's a lot of opportunity right now in the markets we're in and we're very focused on our markets.

Thank you very much.

Dave Rogers, Robert W. Baird

Just a couple left for me. First for Tyler or Jeff, could you talk a little bit about any remaining rollouts in the portfolio through maybe the end of 2015? You mentioned 79,000 square feet in 3Q this year, anything else we should be focused on?

This is Jeff. For 2014, we had another tenant that vacated just this past month and we're obviously in process of talking with a replacement tenant for that space, that's under 26,000 feet. And then in Q3 we got another 90,000 square feet and we're in active discussions with a number of prospective tenants there. And then if you go to 2015, we have already done a fair amount of leasing of space and brought that percentage down from 17.7% down to where it is right now. And so, we've got a couple of 100,000 square foot tenants in 2015 that we're engaging. In fact one of those, we just released that this past month. So, I think we feel pretty comfortable in terms of the roll in 2014, 2015. We've been focused on that for some time and we have no surprises ahead.

And the 90,000 square feet you mentioned, Jeff, in the third quarter, is that in addition to the 79,000 square feet or is that an aggregate number?

That's in addition.

Dave, one other thing I would say just is that one of the things we have said is when we had 17% plus expiration in 2015, we said okay, we need to make sure that we get that number down. We've done that. What's happened is that most of the markets have corrected or continued to improve and we're looking at more robust rent projections than we had initially contemplated. So in some ways, I've kind of said to the guys are we sure we want to release it early or are we leaving something on the table. We're not going to be all together on one side or the other of that, we're going to take some chips off and we're going to see what happens when we think rents are going to increase. So, I just had that comment.

It's a little segueinto my next question I guess, John. With regard to you've got a great problem, which is you have really low availability approaching 400 basis points in the portfolio overall I think. Do you start thinking about other ways other than development to try to kind of get at that market as you're talking about or are you expiring tenants early to try to get new tenants in there, adapt and reuse the new properties, development's clearly one way to do that. Are there other ways you can kind of get at this growth faster?

Let's just say that we have an R&D department that I think is pretty unique and I don't know that we call it the R&D department, but we're looking at some interesting things and I'm not going to talk about them on this call. But we're very focused on how we continue to increase value and do it in a thoughtful way, but we've got to make sure that if we have some new initiatives in various areas that we have the right personnel and so forth. But we look at a lot of things, we do a few things, we try to do it very well, and we'll probably add a few more things to the quiver.

Lastly John, the 300,000 square feet I think of LOIs that you mentioned in your comments, breakdown new versus renewal and then geographically weighted anywhere?

Tyler, do you have that or is it Jeff?

This is Jeff, I can take it. So of the LOIs, 26% of that number is new and 74% are renewals and predominantly the largest are in San Diego 59%, then in LA County 31%, and the rest are fairly insignificant.

Alright. Thank you.

John Guinee, Stifel, Nicolaus.

Whenever Michael Knott suggests there's a rent spike, just agree with him, okay.

Yes, I hear you. It's kind of funny because when we bought 303 Second Street, we assumed that there was going to be flat rents for two years and then it might bump to 3% for a couple of years and of course that would take us to right now when we've had over 100% increase. So, I will freely admit that we were a little bit more cautious and I'm just not going to lay down a big giant bet on everything being perfect for increases. I don't think that's our business.

Okay. A question and I may missed this. But Eli, did you talk about how much more acquisitions. In order to avoid a taxable situation given the sale of the industrial portfolio in Orange County, what your rough estimate is of acquisitions required vis-a-vis a 10-31 exchange? Is there anything else required?

No, there's nothing else required to handle. You're referring to the San Diego I-15 corridor stuff. We pretty much handled all that between the 401 Terry and the Heights and another piece of land that we did. So, there's nothing further required there.

And then also tenant improvement and leasing costs seem to be rather light for the first time in recent memory. Is there a thought process there or is that just a coincidence?

This is Tyler. I mean if you noticed, some of leases were shorter term in nature so I think that's not a trend that we want to provide as an assumption going forward. I think that might correct itself over the next couple of quarters.

Okay, great. Thank you very much.

Steve Sakwa, ISI Group.

Sorry to drag this on. Just real quick, Tyler, I couldn't write down as fast as you could speak. Could you just go back through the $0.04, the $0.02, and the $0.02 so we have it correctly?

So the $0.04 is related to the San Diego land sale that will run through FFO, another $0.02 is related to the accretion from 401 Terry on a leverage neutral basis, and the other $0.02 is just as I sort of said the ins and outs of really everything else that are core. We obviously have some acquisition expenses and legal expenses which are on the negative side of that, but we have better core and some lease termination fees on the positive side of that. So, that was sort of net number so does that help?

And the land sale, is that from second quarter?

That's in second quarter.

Right, thanks. And then I guess, John, for you. You were early in talking a lot about the densification and how that's changing and you've now I guess experienced this with many of your tenants in the last (technical difficulty). Have you gone back and talked to them about just sort of how that's worked and anything that you would say they would do differently today if they had that space or can you see it getting more dense or what problems might be arising from this high densification?

Just like there are automobiles that work better than others, but they all go 60 miles an hour and they all turn right and left, some things are just better done. There are any number of densifications that people have not liked because they've not had the appropriate common areas or they've not had the quality of air, the quality of light or they've not had good elevator systems and so forth. So there has been some bad executions. I'm not aware of anybody those other than astatic in our buildings with regard to these denser areas, and you've seen them. They are spectacular part -- and we've gone through that in our offices.

So, it's a question of whether people have done them right or not, but the short answer to your question is, we've seen people only become more enthused. There have been some articles written and I don't know if you are referring to that, I think it is by some Australian writer that there are a lot of folks that were displeased with densification, they felt they lost their privacy, et cetera, et cetera. But when you bore into that, those folks didn't have the breakout areas, the common areas and all the other things that we have in our building.

So, I think we're going to continue to see all these trends. I'm confident we are because we are seeing it in the way people are improving their buildings right now, in the way they're planning their buildings. We as you can imagine meet with the real estate, see real estate people and human resources people of all of our clients all the time in a lot of tenants that we're talking to about our buildings as well as about our future buildings and I see nothing other than a continuation of this trend.

Okay, thanks. That's it.

Vincent Chao, Deutsche Bank.

Hi, everyone. I'll make it quick. Just another clarification on the guidance. I don't recall hearing the updated same-store NOI growth expectation? I think it was 2.5% last quarter, but just given the strong start to the year, just curious if that's changed much?

I did mention that, but it's roughly the same or may be a little bit better, but we do have some free rent coming into the back half of the year that will lower down our cash NOI then, but -- so we are maintaining the 3.5% percent for now.

Okay, thanks a lot.

Michael Knott, Green Street Advisors.

Hi, just a quick follow-up. On Columbia Square in processing 900, it sounds like strong activity, is that -- would you say it's stronger than almost three months ago? How would you characterize that?

Yes.

On a 0 to 10 scale, 10 for activity or both of those?

David, you want to talk about Academy and I'll talk about --.

So, on the Academy side Michael, and the market what John mentioned in his comments early on, we really see entire property on entertainment news company and it really indicates the kind of demand that Hollywood is starting to see from the media and the tech and especially the entertainment guys. On Columbia Square, they are potential prospect for the new product. In Colombia Square, this Academy tenant who is an interim tenant while we're going to entitlement, have start building, it's outside of the retail which is (inaudible) for. There's one tenant in particular that we've been working with and are advanced in negotiations to take the entire building and a historic, and we've added to the pool of candidates for the new office behind the ones we've mentioned in the past. We've letters of intent towards space planning, etcetera.

So the timing we've laid out in the past with respect to leasing and stabilizing the property continues to feel really good. So on a scale of 1 to 10, it's stronger than it is three months ago. I don't know if it's a seven, eight or 10, but it's certainly stronger.

And then, right word, will this go with yes on my question?

One of the things being a public company until we have something signed we can't -- we're not going to talk about it, but let's just say, we have a lot of action, lot of folks, that's very positive more than we had last month, more than we had the month before.

Okay, fair enough. And then just last one real quick. The DIRECTV been in the news with -- being the target potential of AT&T. They have -- they are your largest tenant over 650,000 feet. Is there any reason to fear that they would need less space under that kind of scenario and they have long lease terms I think?

Well, I haven't really talked to anybody at DIRECTV,I read it just as your (inaudible) I mean, I would imagine the credit of AT&T is greater than the credit of DIRECTV. We've got a 15 years or so to run on the lease. But with regard to the operation itself, like most of these entertainment companies, they are people-intensive and talent-intensive. So, I would speculate if I've said that I don't think they can move. And I would speculate if I said they'd be moved. I don't know anything about it other than what I've read. I would imagine like most entertainment companies you don't see a whole lot of entertainment companies moving to Texas or Dallas or I guess Dallas in Texas, but or Columbia or some place and I mean you just don't see it happen.

Automakers, they're camping LA right, thanks?

Yes.

And there are no further questions in queue at this time. So, I'll turn the call back over to management for any closing remarks they'd like to make.

No more remarks, thank you for joining us. Today we appreciate your interest in KRC.

Ladies and gentlemen, thank you for your participation today. You may now disconnect. Have a great day.