Kilroy Realty Corp (KRC) 2014 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2014 Kilroy Realty Corp. Earnings Conference Call. My name is Lisa and I will be your operator for today. At this time, all participants are in 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, Tyler Rose, Executive Vice President and Chief Financial Officer. Please proceed.

Good morning, everyone. 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 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 a review of the fourth quarter and the year. Jeff will address conditions in our key markets. I will finish up with financial highlights and initial earnings guidance for 2015. Then, we will be happy to take your questions. John?

Thank you, Tyler. Hello, everyone, thank you for joining us today. I'm pleased to report that we had a better than forecasted fourth quarter performance, completing another solid year for KRC. We leveraged our larger operating platform and management team to meet or exceed all of our operations, development, acquisitions and capital recycling. We added several exciting development opportunities to our pipeline. We continue to transform our real estate portfolio to meet the changing needs of the 21st century workforce, increasing the portfolio's long-term value. And we delivered strong financial results, including an impressive total return for our shareholders.

Here's a recap of 2014. We signed 3.2 million square feet of leases across our stabilized and development portfolios, and we ended the year with occupancy of 94.4%, the highest level since 2008, and the portfolio is now 96.3% leased. Our same-store portfolio generated adjusted cash NOI growth year-over-year of 7.5%, and we delivered two Northern California development projects totaling $479 million in aggregate investment ahead of schedule and under budget, creating approximately $225 million to $300 million of incremental value, assuming a range of conservative cap rates.

And we [reloaded] our development pipeline with three San Francisco sites that are expected to have a total investment of up to $1.5 billion. We signed a purchase and sale agreement to acquire South Lake Union development site in Seattle for approximately $50 million. The preliminary forecasted total development cost is approximately $350 million to $400 million depending on the ultimate project size, and mix of office retail and residential.

We acquired two economically attractive projects for $207 million that were immediately accretive to earnings and added meaningful future value creation opportunities to the portfolio. We generated $138 million in proceeds from our capital recycling program, selling five non-core assets. We were recognized for our sustainability efforts with multiple industry leadership awards, including NAREIT's 2014 Office Leader in the Light and the Global Real Estate Sustainability Benchmark's number one ranking among North American real estate companies.

Finally, we funded the ongoing growth and development of our enterprise by executing on all our capital recycling plans and maintaining a strong balance sheet. We raised more than $520 million in new public debt and equity, increased our bank line capacity, while lowering pricing and expand the size of our ATM program.

Now, let me share some of the details from the last three months, then will cover our 2015 objectives. We closed 2014 with a tremendous leasing performance in our stabilized portfolio, signing new or renewing leases on 1.1 million square feet of space in the fourth quarter. That puts us over 2.3 million square feet within the stabilized portfolio for the year. And when you combine that with 835,000 square feet of development-related leases during the year, KR set a new Company record for leasing in 2014. Rents on 1.1 million square feet of leases executing the stabilized portfolio during the quarter were up 27% on a cash basis and up 40% on a GAAP basis.

In our development portfolio, we signed a long-term lease in November with entertainment giant Viacom for 180,000 square feet at our Columbia Square mixed-use project in the heart of Hollywood. It is the largest office lease signed in that market in the last ten years and we believe a clear sign that Hollywood is in the center of a resurgent media and entertainment industry. It also underscores the growing importance of an overall work environment that is collaborative and aspiring to knowledge-driven industries. Viacom intends to unite all of its West Coast media network operations, including BET, Comedy Central, MTV, Spike TV, VH1, and TV land under one roof at Columbia Square's 250,000 square foot Gower Building. Columbia Square office component is now 59% leased.

In addition to the Viacom lease, we recently executed a letter of intent with a well-known entertainment company to occupy approximately 25,000 square feet in the studio and office space at Columbia Square. The pending lease will have a ten-year term with strong rents and will increase the total office pre-leasing activity on the project to approximately 65%. And leasing interest in Colombia Square continues to increase as we are having meaningful discussions with a wide range of tenants for the remainder of the office product. We currently have approximately 685,000 square feet of in-place letters of intent, including 360,000 square feet in the stabilized portfolio, 25,000 square feet at Columbia Square, and 300,000 square feet in our near-term development pipeline.

Turning to our recently completed project in Northern California, we delivered and stabilized the Synposys project in November, beating our completion target and coming in under budget. The two-building 341,000 square foot office campus is 100% leased for 15 years.

We also have good news regarding our recently delivered 587,000 square foot campus in Sunnyvale that is fully leased to LinkedIn. Apple has now subleased 431,000 square feet of the project to the almost 12 years remaining on our lease with LinkedIn. This is a win-win for these two dynamic tech giants and for us, as we now have one of the world's leading companies in our project on a long-term basis.

We continue to make progress at the Exchange on 16th, formerly Kilroy Mission Bay, a fully entitled development project that will total approximately 680,000 square feet in four buildings and is forecasted to cost approximately $450 million. Since the land acquisition in June 2014, we've redesigned the project to appeal today a smarter workforce, including an exterior design that embodies the nearby residential community. We are currently in discussions with a diverse group of tenants that have needs of more than 2 million square feet, including detailed discussions with one tenant for a significant amount of space. We are projecting a construction start mid-year given the significant tenant interest we're seeing.

As I mentioned, we also successfully re-loaded our development pipeline in the most desirable locations on the West Coast. During the quarter, we acquired two adjacent land sites encompassing 4.6 acres in San Francisco Central SOMA district for a total purchase price of approximately $71 million. The two sites located along Brannan Street between fifth and sixth streets are centered in a unique and historic part of the city.

Our plans call for the developing a world-class project that we are calling the Flower Mart. It will include a collection of modern brick and timber buildings that have large loft-like floor plates designed with versatility to reflect the architecture most in demand by the modern urban user. The site has been and will continue to be the home to a thriving wholesale Flower Mart market that will provide an acre for our development plans. As part of our plan, we have entered into agreements to build approximately 125,000 feet of new state-of-the-art flower warehouse and retail space on the site to the existing market. The new wholesale flower market will be a modern, efficient facility designed to draw in new visitors and stage public events like farmers' markets that highlight the flower industry. We're at the beginning of a detailed planning process, so more to come in the quarters ahead.

The sites represent one of the largest and most compelling potential development opportunities remaining in San Francisco, located just one walk away from the [Fort Nebrahans] stop of a future central subway. The central subway projected to be completed in 2019 will be transformative to the city, connecting densely populated residential neighborhoods to significant retail, sporting venues and major technology hubs throughout the city. We believe the subway line, which extends from Chinatown through SOMA to Mission Bay with direct connections to Caltrain, BART, and Muni, will significantly enhance the value of both the Flower Mart and the Exchange on 16th, which are both within walking distance of future central subway stops.

During the first quarter of 2015, we expect to close on our first development site in the vibrant South Lake Union submarket of Seattle. As we discussed on our prior call and at our New York November investor event, we are on track to acquire a full city block along with three smaller adjacent land sites that are currently zoned for approximately 700,000 square feet. The existing zoning permits office, residential and some retail. The purchase price is approximately $50 million or $71 per FAR foot. We project preliminary development cost to be in the $350 million to $400 million range depending on the eventual mix of product types, subject to market conditions, the application process and final permits, which we anticipate obtaining in the next 12 months to 18 months. We expect to be under construction in 2016 with delivery as early as 2018.

To summarize our development pipeline, we have under construction projects. We have near-term developments and we have on the horizon developments as follows. We have six projects under construction totaling 1.7 million square feet and just over $1 billion of investments. The office component is 82% leased. With the addition of the Exchange on 16th and subject to obtaining entitlements at One Paseo, in the Academy, we currently forecast spending $1.4 billion to $1.6 billion on our near-term pipeline over the next two to three years. Finally, for projects further out on the horizon, we forecast investing $1.2 billion to $1.5 billion on the Flower Mart in the South Lake Union development in Seattle subject to final development plans.

As I've mentioned on our earlier calls, we will pursue all of these opportunities with prudence and discipline, keeping a sharp eye on market conditions, tenant feedback, and pre-leasing activity and adjusting accordingly.

Turning to acquisitions, we completed the purchase of a Silicon Valley office campus in November. We've paid approximately $100 million for Chesapeake a floor building 261,000 square feet office campus that sits on 17 acres of land in Sunnyvale, a submarket of Silicon Valley. Adjacent to the 237 Freeway and Caribbean Drive, the project is highly visible as Google, and other major employers continue to expand in this highly desirable area. The campus is currently fully leased with a stabilized yield of approximately 6.4% with 3% annual rent escalations. We view this as a great near-term addition to our portfolio and a longer-term development opportunity.

Finally, to fund our growth and enhance the quality of our portfolio, we continue to make progress on capital recycling. Last quarter, we sold two smaller suburban office properties located in Orange County and San Rafael submarket of Northern California for gross proceeds of approximately $60 million. Earlier this month, we closed a $26 million sale on an Irvine land site that we have held for many years. Tyler will discuss the financial impact of this sale in his remarks. Excluding the portfolio sale we closed in January 2014 and including the recent Irvine land sale, we completed $164 million of dispositions this past year, right in line with our initial projections. Our current plan for 2015 is to sell between $250 million and $400 million of assets although this could change significantly depending on market conditions and the emergence of potential new growth opportunities. We are in the market now with a portfolio of nonstrategic San Diego properties along with a Redmond, Washington property. We anticipate getting initial buyer feedback in the next month or so.

In summary, against the backdrop of a strong West Coast commercial real estate market, the strategic plans that we developed and executed on since the recession has created real incremental value for our shareholders. In 2015, we will continue to follow the same strategies. Specifically, our top priorities are very similar to those we outlined on last year's fourth quarter call. Continue to create value across the franchise and to grow our opportunity pipeline, including expanding entitlements on our various projects. Continue to deliver strong leasing results, both in the core portfolio as well as our development program, while pushing rents and decreasing concessions. Remain laser focused on delivering our development projects on time and on budget, pursue value-add property acquisitions that either add immediate NOI to our portfolio or play a strategic role in our future growth.

Take advantage of improving markets to sell non-core properties to enhance and diversify the quality of our portfolio, continue to build and maintain strong collaborative relationships with existing and prospective tenants. And finally, maintain a strong balance sheet to position us to take advantage of opportunities, both for this and future cycles. [We look forward] to sharing our results with you as the year progresses. Now, I'll turn the call over to Jeff for a review of our markets. Jeff?

Thanks, John. Hello, everyone. Our West Coast real estate markets have strengthened in every quarter of 2014, driven by steadily improving economic conditions, net positive job growth, and rising business confidence and expansion, especially among the region's many tech, social media, entertainment, life science and communication industries. This growth has been concentrated in urban [ethic] centers, already dense with these kind of knowledge-driven, innovation-oriented companies and the millennial workers they employ. This creates a virtuous circle of attraction growth that we see continuing well into the future.

Now, let's take a market-by-market look, starting with the leader, San Francisco. The San Francisco Bay area once again outperformed every real estate market on the West Coast and across the country with technology continue to drive growth. San Francisco had 2 million square feet of positive net absorption for the year, the highest level in ten years with 16 leases executed over 100,000 square feet aggregating more than 3.5 million square feet. There are currently only six blocks of space greater than 100,000 square feet available with 4 million to 5 million square feet of demand, including ten users looking for 100,000 square feet or more.

Class A direct vacancy for SOMA is now near 0%, 9.2% for South Financial District and averaging 5.3% for the Silicon Valley markets. Strong demand and a limited supply pipeline continue to drive asking rents higher. Brokers have reported 88% rent growth since 2010 and approximately 11% year-over-year on a full-service growth basis. Currently, we are 99% leased in the Bay Area.

Greater Seattle also outperformed in 2014. Bloomberg recently named Washington the most innovative state in the nation based on its large technology workforce, high productivity rates and diverse public technology tenants with another survey noting that Seattle is now the Number 1 destination for millennial jobseekers. Demand in Seattle remained strong. Net absorption for the quarter was close to 675,000 square feet, taking the annual total to 2.1 million square feet, surpassing the ten-year average by more than 40% and is 1.5 times greater than a robust 2013 level.

Brokers are reporting 4 million square feet of demand for the region with Facebook, Expedia, Alibaba, among the larger uses of the market. The region saw year-over-year asking rents increase approximately 10%. The strong absorption activity pushed vacancy for the Greater Seattle region down to 11%, the lowest level since 2008. In our primary Seattle submarkets of Bellevue and South Lake Union, Class A direct vacancy rates are now 5.6% and 4% respectively. Our Seattle portfolio is currently 98.1% leased. San Diego market showed strong signs of growth during the year with 1.6 million square feet of net absorption in the region, the highest level since 2005.

San Diego's GDP rose to its new record-high, an increase of 4.3% from the prior year, marking the first time since 2011 that the county's economics growth rate surpassed that of the state in the nation. These figures translate into strong employment growth of 3.2% year-over-year, the sixth highest growth rate for the 25 largest MSAs in the nation, driven by the continued growth in the professional, scientific and technical sectors.

Rental rates continue to increase with overall county rates just 7% below 2008 peak rates and in our Del Mar Heights submarket, rents are just right below peak level. Overall, the county's Class A vacancy rate declined to 11.1% and in our Del Mar and Sorrento Mesa submarkets, Class A direct vacancy rates are now 8.3% and 6.4% respectively. Our San Diego portfolio is currently 93.6% leased.

Los Angeles posted its strongest net absorption since 2005, with almost 2.7 million square feet. This activity was mainly centered in the submarkets of West Los Angeles, Santa Monica, Hollywood, and Playa Vista. Entertainment and technology employment grew at a rate of 5.9% year-over-year, accounting for more than 50% of the leasing activity, while legal and banking made up 20% of the activity. The strong growth was driven by expansion among technology, media, co-working firms such as NeueHouse at our Columbia Square project.

Asking rents in West Los Angeles and Hollywood saw an impressive year-over-year growth rate of 7.7% and 10.7% respectively. We're seeing significantly stronger growth rates in our redevelopment Sunset Media Center and New Columbia Square project in Hollywood of more than 15% to 20% year-over-year. The overall Class A direct vacancy in Los Angeles is currently 15.3%, with West Los Angeles posting 11.9% vacancy rate and Hollywood declining to 5.2%. Across our Los Angeles portfolio, we are now 95.3% leased.

In terms of overall portfolio rents, we now believe that our rents are approximately 10% below market.

Looking at our 2015 expirations, which are now a low of 8.7% compared to 17.7% two years ago, there are only five spaces greater than 50,000 square feet expiring. We will continue to capitalize on the strength of our markets in each of our regions to release these expirations at attractive economics.

That's an update on our markets. Now, Tyler will cover financial results in more detail. Tyler?

Thanks, Jeff. FFO was $0.78 per share in the fourth quarter and $2.85 per share for the year. FFO continues to improve on higher average occupancy and stronger rents. Fourth quarter FFO was higher than expectations, largely due to better than expected operating results, the early delivery and stabilization of the Synposys campus, the November closing of our fully leased Chesapeake Commons acquisition in Sunnyvale, and $0.02 of non-recurring items related to ten reimbursements and legal settlements.

We ended the year with stabilized occupancy of 94.4%, up from 94.1% at the end of the third quarter and 93.4% at year-end 2013. Same-store NOI has grown steadily through 2014, in step with higher rents and higher average occupancy. For the fourth quarter, on an adjusted basis, GAAP NOI rose 8.8% and cash NOI rose 4.4%. For the full year, on an adjusted basis, GAAP NOI was up 6.9% and cash NOI was up 7.5%. From a capital outflow perspective, in the fourth quarter, we acquired Chesapeake Commons on the two Flower Mart site for approximately $171 million.

We've repaid with cash the remaining $136 million of principal on our exchangeable notes in November. We also issued approximately 1.3 million common shares for the value that was above the strike price. These shares were already reflected in our financial statements. To fund these transactions, we sold two properties in the fourth quarter and a land parcel in January for gross proceeds of $86 million. Given the low basis in the land site, we will have a $17 million gain in the first quarter that will be included in FFO. On a per-share basis, the impact to FFO will be approximately $0.19. We also issued $82 million of equity under our ATM program during the quarter.

Taking into account all the transactions, we currently have $120 million drawn under our five-year bank line with the availability to borrow approximately $790 million, including our accordion feature.

Now, I will discuss our initial guidance for 2015. To begin, let me remind you that we approach the 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 of the market intelligence as we know it today and a significant shift in the economy, our market, tenant demand, construction cost, and new office supply going forward could have a meaningful impact on results and ways not currently reflected on our analysis.

Projected revenue recognition dates for new development are subject to several factors that we can't control, including the timing of tenant occupancies. With those caveats, our assumptions for 2015 are as follows. As always, we don't forecast any potential acquisitions or acquisition-related expenses. We currently expect to deliver the first phase of Columbia Square in the second quarter of 2015, while 333 Brannan and the first phase of Crossing 900 in the fourth quarter of 2015, and 350 Mission on a phased basis beginning in late 2015. These projects are all 100% leased.

We expect to complete the Heights of Del Mar at the end of the year, with stabilization in 2015. Depending on market conditions, we expect to commence the exchange midyear. We anticipate 2015 development spending on our six projects under construction and the exchange to be approximately $450 million.

As John mentioned, our current guidance for 2015 is between $250 million to $400 million of dispositions. These dispositions are approximately $0.11 dilutive to our 2015 FFO, at the midpoint of that range. We expect straight line rent in 2015 to increase to approximately $50 million from $35 million in 2014, of which roughly half is attributable to development projects.

We project same-store cash NOI growth between 2.5% to 3.5%. First quarter same-store results will be relatively flat, but cash NOI will grow over the year as free rent burns off and the higher rents come on stream. We expect operating margins to be in the 71% range and occupancy to be approximately 94%. Our recurring CapEx budget is approximately $90 million, which will result in an FAD payout ratio of approximately 85%, assuming everything else stays the same. Depending on the spending on the $90 million is forecasted to be weighted towards the end of the year.

We project issuing unsecured bond to finance our November maturity in the second half of the year. Taking all of that into consideration, we are providing an initial 2015 FFO guidance for our core results of $2.98 to $3.18 per share with a midpoint of $3.08 per share. When we include the $0.19 of gain from the January land sale, our former range increases to $3.17 to $3.37 per share with a midpoint of $3.27 per share.

That's the latest news from KRC and I'll be happy to take your questions. Operator?

(Operator Instructions) Craig Mailman, KeyBanc Capital Markets.

Hey, guys. On the sales chart, I know you said you have the San Diego portfolio and Redmond's coming in the market right now, would that get you more to the low end of the range, of the $250 million to $400 million or [call it] a midpoint, and how much non-core do you guys have left at this point?

Well, let's deal with the first point. With what we have in the market right now in San Diego and the building up in Redmond, we'd be somewhere nearing the midpoint, plus or minus of the range we gave.

With regard to the second point, how much more non-core, remember we are not going to restrict ourself, that's not a signal, but just a comment that we have assets that are well leased for long-term that could be appropriate to sell at some point as well. We are very focused, as I've said before on numerous occasions on debt to EBITDA and so forth. So that's one of the metrics we look at. So when we look at the potential of selling something that's long-term leased, that could be big, we're going to take that into consideration, but ultimately some of those things could be sold, we will see.

And how do you sort of balance that? Cap rates keep moving down, but so is your cost of equity and you guys have the ATM, which you hit a little bit this quarter. Kind of how do you look at the levers of funding development between asset sales and equity?

Tyler, you want to take that one?

Yes, that's a good question. I mean we think about keeping our Company leverage neutral and so as we work on dispositions, it makes sense for us longer term, that will impact the amount of equity. So as we said all along, we're going to raise debt, we're going to raise dispositions, and we're going to raise equity to keep that balance there and we want to focus on debt-to-EBITDA and overall leverage.

Okay. And, then just a last one, the LinkedIn subleased to Apple, I don't know if you guys know but where that sublease was struck, is that sort of in-line with what LinkedIn was paying? And do you guys have any agreements in your leases that is kind of sublease you guys share and any potential upside or is it kind of go to them?

I wouldn't think there's going to be much upside as I understand it. It's incorrect if I'm wrong that it's basically the deal that we have with LinkedIn that Apple was taking. We could have done a direct deal with them, but there is accounting costs when you do a new -- if we were to transfer to a direct relationship with Apple. The nice thing is it works well for LinkedIn strategic planning, it works well for Apple's long-term strategic planning, it's great credit, a great tenant for Kilroy to have. But if you're asking if there is upside to us in the terms of immediate earnings, the answer is no.

I would say the diversification of tenant base adds value to the asset itself. If we're on the market, it would have gone up in value by virtue of the Apple sublease as opposed to stay static.

Great. Thank you.

Michael Bilerman, Citi.

Hey, guys. Manny Korchman here with Michael. Tyler, if we think about your 4Q results, you gave guidance at the end of October, what sort of was the biggest change that you guys weren't anticipating that would have caused you to be so far beyond your internal expectations over the year would end up?

Yes, I mean it was a lot of little things. I mean the Synposys deal came in a little bit earlier than we anticipated. The acquisition closed a little bit earlier. We had higher occupancy than we had forecasted. The disposition was a little bit later. Obviously, our operating results related to the occupancy was better. And then, we had the, I mentioned $0.02 a share of one-time items and that related to the common area maintenance recoveries and some legal settlement. So, it was nothing that drove the whole thing, it was a lot of little things.

Great. And if we think about the Flower Mart in the fact that you're can be anchoring it with a new flower warehouse, how should we be thinking that the rents that flower warehouse we paying, are you cannot offer a discount, because of sort of the deal on the process of getting the building built or is it can be sort of more market?

Well, the $125,000 deal is, we've subsidized and it's not a by itself an attractive yield, but when you take a look at what we think we're likely to get in the way of entitlements based upon the zoning that he's going to do there and consider all the cost, the new facilities above [grade], the new Flower Mart, the land cost and everything else, we think we're going to do exceedingly well.

Right. Thanks, John.

Welcome.

Vance Edelson, Morgan Stanley.

Great, thanks a lot. When we think about the quarterly pattern of lease expirations this year, could you remind us, is the third quarter relatively higher and could you just comment on how you're addressing that proactively and just how good you feel about the mark-to-market there?

Yes, this is Jeff. So, mark-to-market for 2015, it's roughly 8% to 10% below market. I think as I mentioned in my remarks, we've really brought down the number of expirations from a high of 17.7 down to 8.7. We've got five leases at 50,000 square feet or more that are scheduled to roll. Two of those we think, where we've lease, two of those were negotiations. And as I mentioned on prior call there is one please 123,000 square feet in the second quarter will be vacating. So we'll have to reposition that space. So all in all, feel pretty good about the role this year. We've done a lot of work proactively. We have a very manageable role this year now.

Okay, got it. And then with $1.5 billion to be invested in development and more over the long term, could you comment on construction costs and the impact on yield? One of the large REITs in another subsector seem to emphasize earlier this week that rising costs are not going away. So, do you still feel good about all your yield projections and how are you feeling on the construction costs?

This is John. We feel good. We've been able to save money on the LinkedIn deal, we saved money on the Synposys deal. Both of those transactions when we did them a few years back, we projected higher costs than we actually realized. We are really in good shape on everything we've got going on right now and when we forecast what things are likely to be, our tendency has been to forecast greater increases than we've actually seen. So I think we have a very sophisticated and very generally pretty conservative underwriting with a lot of contingency and so forth. So I think we're looking good. I don't see any headwinds there.

That's great. And then, just back on the Flower Mart, given the level of excitement there in terms of your best guess as to when it will be opened for business, are we still thinking 2018 or 2019 or is there any emerging clarity on that?

Well, I think that it's going to take a couple of years to go through all the [entire good] stuff; and then, it's going take the better part of a couple of years to build. So that kind of looks like 2019 and that's our best guess at this point. Whether we can accelerate that some or whether it flips a little bit, I can't tell you; more to come, but we are very engaged in the process.

Okay. Thanks very much.

Brendan Maiorana, Wells Fargo.

Thanks, good morning. Tyler, when did the Synposys development deliver?

November.

In November. So the change in the straight line rent adjustment was pretty significant in the quarter. I think it went up about $9 million sequentially from Q3 to Q4. I would guess that the Synposys deal maybe added a couple million dollars on that, but what sort of makes up the remaining $7 million change between Q3 and Q4?

Yes. I think it was a total of $8 million and most of it was from LinkedIn and some of it was from Synposys as you're pointing out. But LinkedIn came into the portfolio in September. So there were a little bit in September, but the bulk of it was really the LinkedIn.

Okay. So that's not much on the existing portfolio. So if I think about the same-store guidance of 2.5% to 3.5%, 4% for 2015, it feels like occupancy is going to be about flattish, rent spreads are I think as Jeff mentioned, up 8% to 10%. Last year, you had rent spreads that were up 13% and you've got bumps. It feels like maybe 2%, 2.5% to 3.5% would be a little bit lower just sort of based on those major inputs that I would guess. Is there anything else like some free rent or something like that, that's going to impact the number there otherwise?

Yes. Now, I think you got it right. I mean the one other thing that impacts the number is we did a fairly largely lease in San Diego last year, which had a rent roll-down and it has free rents that kicked in in January, just this month. So that was a fairly substantial lease. So that actually has a reasonable impact on the same-store results.

Okay. And that kind of stuff burns off as you move later in the year?

Exactly. So by the end of the year, the same-store numbers will be improving.

Okay. And then, just last one, you mentioned development spending, $450 million; CapEx spending of $90 million; is there any other capital spending like first-generation CapEx spending that doesn't hit development or if we're thinking about sources and uses or is that pretty much it?

We have some minor first generation, but it's probably $25 million or less, so it's not material.

Okay. Alright. Thanks for the time.

Jed Reagan, Green Street Advisors.

Hi, guys. Just a question on cash releasing spreads. Those were really strong last quarter and quite a bit higher than the mark-to-market rents you guys have talked about. Just wondering if you could talk about what drove that, was that market mix or there is some lumpy leases with some outsized markups, maybe just little color on that.

Yes. I mean I don't think there's any one thing. I think Seattle particularly had good rent roll up just last quarter, but there was nothing that really jumped out.

Okay. And you mentioned the leasing LOIs, [do you offer] any more details on that, maybe which markets or projects those are concentrated and especially on the near-term development LOIs you talked about?

We have a lot of confidentiality and non-disclosure agreements regarding this kind of stuff. All these tech companies particularly are nuts about confidentiality. So the 25,000 feet we mentioned was in Columbia Square. The 360,000 square feet in the core, Jeff can speak to in a minute. The 300,000 square feet that is not under construction, but a near-term development. There are not that many. I mean, you've kind of figured it out, I'm not trying to be cute, but I have to maintain confidentiality.

Sure.

Jed, this is Jeff, in terms of the LOIs in the [stable] portfolio, it's pretty diverse. 35% is in LA, San Diego is probably 15% and San Francisco is about 30%, and Washington is 20%. So, we've got pretty good dispersion of LOIs across the portfolio.

Okay. And just last one, One Paseo, I think you've got the Council hearing coming up next month, maybe just how you're feeling about chances there and then what additional hoops you might have to jump through beyond that if that was successful?

Well, this is John again. One Paseo, I think you all coined the term that I use regularly now when I speak to the City Council people and the Mayor down at San Diego, entitlement purgatory, I'm not going to -- I borrowed that phrase, Jed, I like it. I don't know whether that was Michael who came up with that, but that's a good one and you can get into purgatory here in California. We got into it because of the Mayor that was a creep and thrown out and so forth, but in any event we're feeling pretty good about getting City Council approval at the end of next month and assuming we do and we think we will based upon what we're hearing today that the likelihood is that we'll get a CEQA challenge.

And CEQA is the California Environmental Quality Act, which is a nice name, but like so many of these laws really is for $38, anybody can file a lawsuit against you. And as you know, you have to then go to court if you get such a challenge and you then debate it on the merits of your environmental impact report and to give you an idea, in our environmental impact report, not only did we have all the traffic consultants and all the other people that [are applying] on the environmental impacts, but then we did peer-review, then we did triple peer-review, then we did quadruple peer-review, the same thing with lawyers and all the rest.

So, our feeling is based upon what our lawyers are telling us and all our advisors that if we have a SEQA challenge, we should do well, but again anytime something goes into the legal system, there is uncertainty. But we're feeling good about getting City Council approval from what we think the way we're reading the tea leaves and then we'll see if we get the challenge and if we do, that can be a six to 12-month process, and our hope is that we get through all the stuff because the markets come our way, there is very strong demand for the retail, very strong demand for the apartments and with a very good demand at rates that make sense for the office. So we'll hopefully get this thing out of entitlement purgatory and on the books.

Sounds good. Thank you.

Welcome.

John Guinee, Stifel.

Great. A couple of questions here. First, just as curiosity, somebody had told me and correct me if these numbers are wrong, but that Salesforce.com now has a leased space or committed space of about 3 million square feet in San Francisco. At 150 square feet per person, that's 20,000 employees. Are those numbers even close to correct because that's an amazing employee base for that company?

Yes. This is John. Obviously, I can't speak other than what I read and what I've been told that I'm not the -- like I can't speak for Salesforce, but I do know that Salesforce has been getting out of quite a bit of space. Their intent, as I understand it, is to occupy 50 Fremont, which they're in the process of buying from TIAA-CREF, which is already in, about 0.5 million square feet or so. The entirety of our building 350 Mission and then the bottom of the Transbay Tower and to get out of the other space that they're in the city. And I know their expirations on that space are sort of 2017, which sort of fits when they're getting into some of the other space that I mentioned that's under construction. So I think what you're going to see is kind of a student body shift from the buildings they've been in to the buildings that they want to be in. And in terms of the number of people that you mentioned, I know they have 16,000 people worldwide, I don't know how many of them are in San Francisco.

Very, very helpful. But then, the second question probably for Jeff, it's a little bit surprising to see the TIs and LCs still being about $35 a square foot on average, and so the question is how much of that is deriving rental rate growth? Two, should that number come down? And three, how do you look at the commodity assets in secondary markets and their ability to graft off the better markets in your primary geographic areas?

Jeff, do you want to take the first two and I'll take a third?

Sure. Yes. So, I think the $35 of TI, John, it's obviously space by space, but I think that still feels like on average, what we're seeing, obviously, in some of our bigger deals, we're actually putting up less TI; in some case, we're putting more. So, I think $35 still feels sort of down the middle of the fairway. So I think that that answers the first question. Your second question was?

Does the TI packages drive rent growth?

Yes. I don't think so. For the most part, we are seeing what doe it take to [doctor] the space to get the high market rents and obviously we've got great buildings in great locations. So we're not really putting a lot more TI to get rent growth, we're putting in the TI that's necessary to deal with the tenant that needs to occupy the space and we really push really hard with our construction teams to have a high residual value and try to engineer it so that we're maximizing the type of improvements we're putting in, the design we're putting in, so we have life after tenants. So, I think that feels still pretty good and we're still seeing concessions dropping in a lot of our markets as the markets tighten up. So I think that trend will continue as we look down the field here.

John, was the third question how should the lower-quality assets [drape off] the rents and performance of the top assets? Is that kind of, you're phrasing it?

Yes, there have been a couple of big transactions lately of a commodity product in sort of commodity submarkets, particularly in the Bay Area. And the question is whether the rent growth you're seeing in the primary markets and A-quality assets if the secondary assets can draft off of that or not?

Well, I'm going to ask Eli in a moment to opine on that as well. I mean, obviously, if there is very little available in a market and people need to be in that market, then they have fewer choices and to the extent that they decide to stay in that market, then they're going to have to take lower-quality product by definition. So yes, in that context, it's pretty basic economics, but moving out to lower-quality areas, I mean, I still look at some of the San Jose market in South San Jose and say, it's a no man's land. You really wonder when that would come back.

Obviously, B-quality buildings are going to move up of the ladder as the tide comes in and there is less space in the A market. But I think in the longer term, what we're saying and I'd just put it this way, in terms of strength of demand in the markets and where we see big companies going and medium-sized companies beyond all the comments that Jeff or I made in out formal script, we are having far earlier than expected discussions for meaningful amounts of space with a number of companies for the projects that we have on the boards, whether it's the project in Seattle or the project at -- the Exchange at 16 or Flower Mart or San Diego, far earlier than you normally have these discussions for a huge blocks of space that are -- and these are with companies that are generally not on any brokers list and the common theme is we need to step up and provide the kind of environment that attracts and retains people.

So I think in the short term, in hot markets where there is little space, it does impact positively the B product and it does -- the increments impact positively, the little more outlying product, but long term, I believe and this is where I think we made some good bets that have paid off, longer term, there is this need and recognition of the need to upgrade facilities. So, longer term, I don't know what that means to those assets. You can see what we think as we've been selling those kinds of assets off. Do you want to add anything to that, Eli?

That's pretty thorough. I mean I would add one thing, which is the way it is right now is at least from a radius perspective, when you go to the edge of the radius where things are strong and you compare it to some other historical time seven or ten years ago, the drop-off is quicker, location and the locations that we're putting our buildings or have our buildings are within that circle and sometimes that circle expands and when it does, the rents go up very quickly in those outlying buildings, they go up more than they would have, because the gradation between being [tied] in the circle and being further out used to be gradual. Now, it's abrupt. So, that's -- you covered it pretty well. So --

Great. Thank you.

George Pavey, Credit Suisse.

Great, thanks. Jeff, your comments on San Diego were more positive than, I think we've heard in some time. To what do you attribute the positive momentum in occupancy and pricing power? Just given that I sort of think about San Diego as more of a fire attendant market than a technology, new media-driven market that seems to have driven most of the West Coast markets so far this cycle.

Yes, this is David, George, I'll answer that. I think what we're seeing is we're seeing a lot of biotech and life science growth down there and that's where we're seeing a lot of the push and lot of the expansion and it looks like they're going to continue to grow. So that [leads to] I think most of it. There's technology down there as well and there are the industries that have been there for a long period of time that are continuing to expand or getting into other things like robotics, there is Medtech and there is a lot of healthcare. So, I think that's where most of it's coming from.

I will add to that there. What we're also seeing is a continuing kind of trend of law firms to be more in the Del Mar market than some of the other markets; and of course, the money managers, the same way; money managers tend to want to be around where the wealthy people live and where they live and in the wealthy communities; and that bodes well, I think for that space; but it's -- you fire category, you're right, George, has been big in San Diego and it continues to expand. And all these things collectively have consumed most of the quality product. And so, there are a lot of discussions now about people needing space and we hope that bodes well for us. By no means is it robust like San Francisco, but it's moving in the right direction and we're very pleased to see that.

No, that's helpful. Thank you. And last one from me, a question for Tyler. I guess, to follow up on Brendan's question on straight-line rent, is it fair to think that if you had $17 million of straight-line and free rent in the fourth quarter, but that's a pretty good number to use, again in the first quarter, just given the free rent periods in some of these development leases. And then, in sort of the second quarter and third quarter, we speak more like a $10 million or $11 million rent rate for straight-line rent.

Yes. For the first quarter, you're right, it's approximately the same as the fourth quarter and then it does [trail] off. I think one of the developments, the rent starts in April. So that will trail off in the second quarter and so it will move down to that $12 million, $10 million level by the end of the year.

Great. Thank you.

Jamie Feldman, Bank of America.

Great, thank you. I guess, Tyler, just sticking with that topic, did you provide a per share FAD outlook for 2015? It seems like you have some moving pieces on the adjustments.

Have we provided, the answer is no, we have never done that before and we gave a payout ratio forecast in the high 80s, mid-80s. But we haven't done that.

Okay. And then, how do we think about dividend growth and your prospects in 2015?

John, do you want to handle that or --?

Well, it's more to come. Don't have a statement for you right now.

Okay. You said the 85% is the FAD payout ratio of the dividend. Right?

Yes, yes.

Okay.

Yes. As John said, I mean, we're not going to comment on the dividend policy, but we're covering the dividend nicely this year.

Okay. And then, I think you said the 2.5% to 3.5% same-store, that's on a cash basis?

Yes.

Do you have a sense of what it would be on GAAP? Could you -- it seems like you have a lot of swings in the straight-line rent.

Yes, it's going to be a little bit higher than that on a GAAP basis.

Okay. And then, I guess just thinking about the markets themselves, can you guys talk a little bit about what you're seeing in terms the cap rates, maybe movement in the quarter and maybe the last six months, especially in like a San Diego or some of the markets that have been a little bit more of a laggard in the cycle?

Sure. This is Eli. Yes, we definitely see movement in the last three months as well as the last six months. If you look back a year ago, I'll kind of talk about overall returns. If you look about a year ago, maybe we were at a 6.5% or call it color core IRR targets. And I think when I was asked about this last quarter, I thought we've gotten to 6% flat, and frankly I'll just give you one data point that I think will be emblematic that -- and at this point, I think we've cracked down to 5.75% on core stuff, and I think that's a combination of a moderate level of inventory, the debt rates are lined up so well.

I mean right now, if you combine rates and spreads, the only limiting factor is now banks are putting a floor on how low they will go because the spread plus the underlying rate is down in the low 3s for the ten. And so they're maybe capping it at 3.5%, and then the foreign capital flows continue to strengthen. There was a recent transaction here in a very strong location on the San Francisco Peninsula, the top five buyers were foreign from three different continents and the pricing was $1,800 a foot.

And so I think that's emblematic that it's continued to tighten their -- and then you ask about sort of outlying. What I can tell you is that on the things that we're selling, we get robust interest. We have things in the market in San Diego and we're in the middle of that. So I don't want to talk about them too much, but for example, something like that we received 130 confidentiality agreements signed from people who were interested in [perusing] that and that is really deep activity and we have deep interest and deep activity for those assets. And so, yes, I think it's strengthened for core and I think it's strengthened for things below core materially, notably, not -- yes, notably, I would say.

Okay, alright. Thank you. And then, I guess, Tyler, one more question on the guidance, do you include any equity in your 2015 outlook?

Yes. It depends obviously on the disposition level, right. So we have different models for different levels, but as I said, we sort of manage the equity with the dispositions and the debt to sort of keep our leverage neutral. So you can back into that number.

So there is an assumption in the base case?

Yes.

[We assume ATM] issuance over the year.

Okay. Alright, thank you.

Gabriel Hilmoe, Evercore.

Thanks. Tyler, just going back to the occupancy guidance, I know you mentioned the 120,000 square foot moveout in San Diego, but just curious is that asset in the bucket that's being marketed for sale?

Yes.

So I guess even if I include the large moveout, I guess I would have expected the occupancy number for next year to be a little bit higher given where you ended 2014 on a leased rate basis. Can you just walk through some of the other ins and outs that are driving that number, the 94%?

Right, you're right, but that tenant obviously was in the building at the end of last year. So that's one of the reasons the number is going to be higher, but it's just [frictional] occupancy and so with the ins and outs and some smaller expiration, that's -- our base case is 94%. Obviously, we hope to do better than that, but we're within spitting distance of where we ended last year.

Alright. Great, thank you.

There are no additional questions at this time. I would now like to turn the presentation back over to Tyler Rose for closing remarks.

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

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