Kilroy Realty Corp (KRC) 2015 Q4 法說會逐字稿

Good day ladies and gentlemen and welcome to the fourth-quarter 2015 Kilroy Realty Corporation's earnings conference call.

(Operator Instructions)

As a reminder, this call is being recorded for replay purposes. I would now like to turn the call over to Tyler Rose, Executive Vice President and Chief Financial Officer.

Good morning everyone. Thank you for joining us. On the call with me today are John Kilroy, Jeff Hawken, David Simon, Heidi Roth, Mike Sanford, Rob Paratte, 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 eight days both by phone and over the Internet. Our earnings release and supplemental package have been filed on Form 8-K with the SEC and both are also available on our website.

John will start the call with a view of 2015 and 2016. Jeff will discuss conditions in our key markets. I'll finish up with financial highlights and a review of our initial earnings guidance for 2016 that we provided in this morning's release. Then we will be happy to take your questions.

John?

Thank you, Tyler. Hello everyone and thank you for joining us today. I'll start my comments today with a brief review of the West Coast market conditions, then I'll cover 2015 highlights and I'll finish with some color and outlook for 2016.

While we recognize that there are macro factors creating uncertainties about the capital markets and future business conditions, West Coast market fundamentals for office space continue to outperform. We see strong a demand and limited supply for the type of work environments that our tenant base requires. Rental rates and net absorption continue to increase while vacancy rates continue to decrease year over year in the innovation-driven markets of San Francisco, Seattle, Los Angeles and the submarket of Del Mar in San Diego.

Cap rates and IRRs on West Coast transactions continue to reflect strong demand for quality real estate. While Bay Area VC funding in the fourth quarter was down from the highs of 2014 and early 2015, it is still well above the healthy levels of 2011, 2012 and 2013 which was a period of considerably higher vacancy rates. Already early in the first quarter brokers are advising that there are currently 750,000 square feet of new leases in process in the San Francisco market.

Against this backdrop, KRC had another strong year of operating performance in 2015. We exceeded every one of our internal targets. On leasing performance we signed 1.5 million square feet during the year, exceeding our goal of 1 million square feet with strong cash rent spreads of 22%.

On year-end occupancy, we provided initial guidance of 94% and ended the year at 94.8%. On same-store cash NOI growth, we provided an initial guidance range of 2.5% to 3.5% and achieved 4.7% for the year. And on FFO and FAD per share we initially provided FFO per share guidance of $3.27 and increased it $0.12 throughout the year.

We beat our FAD per share budget by more than 25% with a payout ratio of 66% at year-end. We managed our development program with great focus and discipline, delivering fully leased under-construction projects on time and on budget, securing critical entitlement approvals for future projects and reloading our pipeline on a selective basis with projects that offer clear value creation opportunities.

We maintain a strong balance sheet and availability to capital, exceeding our capital recycling targets, raising $790 in new public debt and equity, decreasing debt to EBITDA from 7.4 times last year to 5.7 times this year and earning credit grade upgrades from both major rating agencies. More specifically on the operations front we finished the year with fourth-quarter leasing activity of approximately 398,000 square feet of new or renewing leases at rents that were 15% higher on a cash basis and 25% higher on a GAAP basis. This strong leasing performance resulted in better than expected cash same-store growth of 9% in the fourth quarter.

We also have 350,000 square feet of LOIs currently in place. This continued strength in all of our markets not only translated into strong operating results but also increased interest in all of our development projects. Last quarter we delivered and stabilized our two building, 339,000 square foot office project at Crossing/900 in Redwood City that is fully leased to Box.

Combined with the delivery of the 100,000 square foot NeueHouse space at Columbia Square last summer, these two projects represent a total estimated investment of $270 million with an average stabilized cash ROIC of more than 8%. Based on today's cap rates value creation of both projects is estimated to total approximately $275 million, effectively doubling our investment or doubling the investment. That leaves us with six projects under construction or in lease-up.

Two of the six, salesforce and Dropbox, will be delivered fully leased in the second quarter. The new office component of Columbia Square will be complete from a base building perspective this quarter. It is 58% leased with good activity from both large entertainment users and from smaller prospects with whom we are currently negotiating LOIs.

The residential component of Columbia Square will begin its projected one-year lease-up phase in the second quarter. The Heights at Del Mar is now in lease-up with lease negotiations in process for two of the three floors. And as you know last summer we started the Exchange on 16th and Mission Bay with a total projected investment of $485 million.

The project is expected to be completed in the third quarter of 2017. We remain in advanced negotiations with several prospective tenants and we are seeing interest from new prospects on a regular basis.

On the entitlement front we made significant progress on both One Paseo and The Flower Mart during the year. We effectively settled all remaining outstanding leases -- rather, outstanding issues with the community groups and surrounding neighbors on the One Paseo mixed-use project in Del Mar. In San Francisco at the Flower Mart site we successfully found common ground reached agreements with local community groups, and we're making great progress on entitlement and design for both projects.

Finally, we acquired two additional development opportunities in 2015 for an aggregate purchase price of $128 million. 333 Dexter in the popular Southlake Union neighborhood of Seattle and 100 Hooper are fully entitled sites in San Francisco.

To fund our growth and take advantage of the strong market for real estate we continue to have success with our capital recycling program. In mid-January we closed the sale to Intuit of the entire office campus it leased from us in San Diego for a purchase price of $262 million. The campus has four buildings encompassing roughly 466,000 square feet.

We also sold a nonstrategic 7.6 acre parcel of land at Carlsbad for $4.5 million last month and we are in discussion to sell the remaining adjacent three parcels. Combined with the transactions we completed in 2015, which consisted of 10 buildings and a land parcel, we have generated $602 million of proceeds since January 2015 to help fund our development projects. Tyler will provide more detailed disposition guidance later in the call but we continue to be very aggressive on this front.

Now let's move to the year ahead. Based on our discussions with global heads of real estate, executives of companies in our markets and the brokerage community, demand continues to look strong against the backdrop of low vacancy rates, low availability of contiguous blocks of desirable space, constrained supply and increasing rental rates. We are encouraged that numerous companies are in the planning stages for significant new requirements over the next two to four years in all of our markets.

On the transaction front, cap rates remain very favorable with a deep and diverse pool of buyers. Of course, we don't have a crystal ball so we can only report on what we're seeing and hearing. We will continue to take our lead from the conditions we see on the ground, making decisions as we move through the year with the same discipline that we have always exercised.

Our overriding goal remains the same: to preserve and build long-term value for our shareholders. That is why we remain committed to markets with strong, long-term growth dynamics and those that attract an innovative workforce and the growing companies that need their talents.

That is why we are adamant about location in these markets, seeking out neighborhoods with distinct cultural personalities, attractive lifestyle amenities and excellent access to public transportation and the other required services. And that is why we are prudent in our decisions about when to pursue each new development project.

As most of you know, we have a strong track record of pre-leasing. Approximately 80% of our development has been leased upon construction completion and 90% upon stabilization. And all of the projects were built at very accretive returns.

As stated in prior conference calls, we have four potential near-term development projects, any of which could start this year subject to macro and market conditions.

100 Hooper Street, located in the Soma district of San Francisco, is fully entitled and we can start construction at any time. Our strategy here remains the same. We will wait for significant leasing momentum at the Exchange or Hooper itself before we break ground.

One Paseo, our mixed-use development project in Del Mar, is expected to have final entitlement approval by the summer. And at both the Academy in Hollywood and 333 Dexter in Seattle we expect final governmental approvals by the third quarter.

Further out on the development horizon is the Flower Mart project in San Francisco. Our expected timeframe to move forward is about two years, again subject to market conditions and receipt of entitlements.

To wrap up we believe we are entering the year with a premier West Coast office portfolio, a development pipeline that will create substantial value over time and as always a strong balance sheet. Our key objectives for 2016 are to continue to execute a strong leasing program both in our stabilized portfolio as well as our development pipeline, capture embedded rent growth, deliver new properties on time and on budget, succeed with our capital recycling program and maintain our financial strength.

With that I will turn the call over to Jeff for a closer look at our markets.

Thanks, John. Hello everyone. As you all know, our West Coast real estate markets were among the strongest in the nation last year, led once again by exceptional growth and demand and absorption in both the San Francisco Bay area and Greater Seattle.

Starting in San Francisco, metrics continue to move in an upward positive direction. 2015 topped last year's historical high in net absorption of just under 2 million square feet with a new high of 2.1 million square feet. Similarly, rental rates grew roughly 13% year over year on top of 2014's 11% growth rate.

Demand exhibited similar growth with 19 companies currently seeking spaces greater than 100,000 square feet. Against the backdrop of these strong fundamentals, for the full-year 2015 we executed 381,000 square feet of leases in the Bay Area with rents 43% higher on a cash basis and 53% higher on a GAAP basis. We are currently 99.1% leased and our in-place rents for the region are approximately 32% below-market.

In Greater Seattle fundamentals also continue to increase as large technology companies including salesforce, DocuSign and Juno Therapeutics expand their footprint. Net absorption for the year totaled 2.5 million square feet, surpassing the past three years' 2 million square foot average. Rents increased 7.5% year over year to hit a 10-year peak.

In 2015 we signed more than 236,000 square feet at cash rents that were 18% higher than prior rates and GAAP rents that were 36% higher than prior rates. Our Seattle portfolio is currently 98% leased and our in-place rents are approximately 8% below-market.

In San Diego despite the quarter's slight negative net absorption primarily driven by QUALCOMM's vacancy the year posted positive net absorption of 555,000 square feet. Rental rates surpassed pre-recession 2,008 levels and there were 11 new class A leasing transactions greater than 20,000 square feet in 2015 after only three in 2014.

In 2015 we executed nearly 350,000 square feet in San Diego at cash rents 3% above prior rate and GAAP rents 15% above prior rates. Our San Diego portfolio is currently 90.9% leased, driven by the moveouts we discussed last quarter. Our San Diego in-place rents were approximately 7% above market.

In Los Angeles creative services and entertainment continue to drive rents higher and vacancy rates and cap rates lower, particularly in the selective markets of West LA, Playa Vista, Beverly Hills and Hollywood. In 2015 we signed almost 475,000 square feet of leases with rents that were 15% higher on a cash basis and 19% higher on a GAAP basis.

Across our Los Angeles portfolio we are now 95.6% leased. Our in-place rents there are approximately 15% below-market.

Across our entire portfolio we now estimate our rents are about 16% below-market. Given our strong leasing performance over the past few years our lease expirations in 2016 total only a little over 700,000 square feet, representing 5.8% of the total leases.

Almost half of the 700,000 square feet is in Los Angeles and a third is in San Diego. Rents on 2016 expirations are approximately 15% below-market.

That's a review of our markets. Now Tyler will cover our financial results in more detail. Tyler?

Thanks, Jeff. FFO per share was $0.80 in the fourth quarter and $3.39 for the year. That's an increase of 19% over our 2014 results.

FFO improved across the year on higher rents, contribution from new development and land sales. We ended the year with stabilized occupancy at 94.8%, better than we projected primarily from early move-ins. We ended the year with a stabilized portfolio of 96.1% leased.

Same-store NOI has also grown in step with higher rents. Adjusting for nonrecurring items, cash NOI was up 9% and GAAP NOI was flat in the fourth quarter. For the full-year, adjusted NOI grew 4.7% on a cash basis and 3.6% on a GAAP basis.

During the fourth quarter we repaid two maturing mortgages totaling $90 million as well as $325 million in maturing bonds. As John noted we completed the sale earlier this month of four adjacent office properties encompassing 466,000 square feet that make up the Intuit campus in San Diego and a 7.6 acre land parcel located in Carlsbad for total proceeds of $267 million.

These assets were held for sale at the end of the year. Taking our current financial position and the recent completion of these sale transactions we have approximately $290 million of cash and $25 million drawn on our $600 million bank line which is expandable to $900 million.

Now let's discuss our initial guidance for 2016. To begin, let me remind you that we approach our near-term performance forecasting with a high degree of caution given all the certainties in today's economy. Our internal forecasting and guidance reflect information and market intelligence as we know today.

Any significant shifts in the economy, our markets, tenant 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. Projected revenue recognition dates for new development are subject to several factors that we can't control including the timing of tenant occupancy.

With those caveats our assumptions for 2016 are as follows. As always we don't forecast any potential acquisition or acquisition-related expenses.

We anticipate 2016 development spending on our projects under construction to be approximately $250 million. As John noted earlier we expect to deliver 350 Mission Street to salesforce and 333 Brannan to Dropbox in the second quarter. At Columbia Square in Hollywood we expect to commence leasing on the residential units at Columbia Square in the second quarter with stabilization 12 months out.

Fender is projected to take occupancy in the fourth quarter and Viacom at the end of the year. We expect straight-line rent to average $9 million per quarter. Approximately 60% of this is attributable to development projects.

We project same-store NOI growth of 6% to 8%, I should say that on a cash basis, substantially higher than 2015. First-quarter same-store results will be relatively higher than the rest of the year.

We expect operating margins to be around 71%. We expect year-end occupancy to be in the 94.5% to 95% range. Our recurring CapEx budget is approximately $80 million which would result in an FAD payout ratio of approximately 65% to 70% assuming everything else stays the same.

Depending on development starts and market conditions we could issue bonds to help fund new development spending given our low leverage. In terms of capital recycling our current range is between $350 million to $650 million with a $500 million midpoint which includes the $266 million already completed.

Taking all this into consideration, we are providing initial 2016 FFO guidance of $3.31 to $3.51 per share with a $3.41 per share midpoint. This is up 7% from $3.20 per share in 2015 excluding the land sale.

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

(Operator Instructions) Ross Nussbaum, UBS.

Hey John, good afternoon. Can you talk about the exchange a little more?

I think last time we got together toward the end of last year you had talked about also I think being far down the road in negotiations potentially and tenants that could take half or all the buildings. Can you characterize how have things changed or progressed in the last couple of months with respect to leasing of that asset?

I think they are on track with what we all talked about at NAREIT and so forth. We do have one very large transaction for the entirety of it.

As I stated back then it's up for Board approval in the first quarter of this year. We don't know if that's going to be this month or which is now February or next month.

We're told it's likely to be this month. So we're encouraged by that. We have other transactions, one which is for approximately half which is going up for approval as well.

The timing, I don't know, Rob, whether you know on that whether that's now --

First quarter.

First quarter. And then a number of others behind that. Since that time, since NAREIT we've had a number of new RFPs and whatnot.

So we now have a mixture of tech, non-tech, medical, life science, a variety of different uses that want the building. And our goal there is to make sure that we create the maximum value for our shareholders and there's a couple of deals that we think would be extraordinary. So we're very focused on those.

Okay, I appreciate it. And then maybe the same question on 100 Hooper. You mentioned in the comments that you're going to wait for leasing momentum or further leasing at The Exchange, but can you characterize the level of discussions you're at on 100 Hooper specifically?

Yes, I'm going to ask Rob to do that. Remember we just bought that site a few months ago and we spent a little time redoing the design. But Rob would you just go through the project quickly, where it is in terms of the two different uses and where we are please?

So we have about 400,000 square feet entitled with Prop M allocation. That's an important distinction to make. Approximately 80,000 square feet of that is the PDR space, production, distribution and repair space.

We have a very good credit tenant that is looking at potentially taking a good portion of that PDR space and they are also evaluating perhaps taking some office space in addition to that. But as John said earlier, we're really focused on The Exchange and executing on the activity we have there.

Thanks. I will jump back in the queue.

Manny Korchman, Citi.

Good afternoon, guys. I just had a question, so I believe when Jeff was going through his comments he said that there were 19 requirements over 100,000 square feet.

On the last call I think that was up to 26 but I didn't think there was that much space available in between for sort of those requirements to get taken up. So maybe you can give us an update on what happened to the ones to go from 26 to 19.

Well, a portion of them -- I mentioned in my comments that there's roughly, according to the brokerage community, about 750,000 square feet of deals what we are told are fairly imminent. So I think the lion's share of the difference is in that 750,000.

Okay. And then Tyler, on your guidance to get to 94.5% to 95% occupied, why wouldn't that number approach your lease percentage number rather than only up a handful of basis points from where you are now?

Yes, well actually it's right in line with where we are now. So we're effectively, we closed the year at 94.8% and our guidance is effectively in that same range.

That's due to we have 700,000 feet rolling in 2016 and we'll be making some of those renewals as others we're anticipating not making, so it's just the normal churn. We're effectively at frictional vacancy at this point, so it's just the normal churn at this point.

Are there any big lumpy known moveouts in there that we should be modeling?

Yes, this is Jeff. In 2016 we've only got two leases that are 50,000 square feet or greater.

One is in San Diego and we've already got advanced negotiations on a prospective tenant to take that space. And the other one is 90,000 square feet also in San Diego and that tenant is going to remain in about half of that building and everything other than that is sort of smaller leases. We have 94 leases rolling this year, so a lot of them are much, much smaller square footage.

Thanks guys.

Craig Mailman, KeyBanc Capital Markets.

Hey guys. Tyler, on the guidance for dispositions it seems a little light relative to the $500 million to $1 billion you guys had talked about at NAREIT. Is there something that fell out of negotiation that you guys were considering or is this just a more conservative number that could grow throughout the year?

This is sort of a core disposition amount that we're talking about versus any more strategic transactions. So we've been selling at roughly this level for the last few years. And so no, this isn't any different than what we talked about, I think this is just the core amount.

Okay, so that I think John was talking about a deal last year that could be kind of more sizable, maybe strategic joint venture. So that's still on the table but just not included in guidance?

Yes, this is John, Craig. We have a number of sovereigns that want to do deals with us. We're contemplating what we want to do and how we want to proceed.

So as Tyler mentioned the guidance range on dispositions is just straight up asset sales. And yes, we're still contemplating that. We haven't come to a conclusion yet.

Okay. Then just one last quick one.

The expected spend on Academy kind of jumped sequentially. What's behind that?

Do you want to cover that, David?

Yes, I got it. You know, refinement in scope changes and increased size, so the project is bigger than was originally anticipated.

We were able to get some more square footage and we refined the scope. And commensurate with that are rental rates, so from a yield perspective we're in the same place where we were two years ago when we acquired the land. So it feels pretty good.

Perfect, thank you.

Jamie Feldman.

Thank you. Tyler, so focusing on the 6% to 8% cash same-store growth, can you just walk us through the major pieces that gets you there?

Because it sounds like your occupancy is relatively flat. And you're losing or you may even be losing some space.

No, I think the big jump in same-store cash is the burn off of free rent. So we've had, you can see the difference we had in the fourth quarter between our cash and our GAAP same-store numbers.

And we're going to continue to have a little bit of that in 2016, particularly at the beginning of the year where we're getting the real benefit now of some of the leases we signed over the last couple of years that had some free rent in them. So it's being driven by higher or less free rent I guess.

Okay. So what about on a GAAP basis how do you think it will look?

So on a GAAP basis we're estimating sort of 2% to 4% growth.

Okay. What are you assuming for leasing spreads?

Well, we've said that the overall portfolio I think in 2016 is 15% more market -- 15%.

Okay. All right. And then John, you had mentioned several companies in planning stages for significant new requirements in markets over the next few years.

Would you say are there any new ones to the pipeline or these our conversations you've been having for a while? Just maybe an update on what companies and tenants are feeling and thinking these days watching the stock market decline and other macro issues?

Okay. I'm going to ask Rob to jump in a second on it, too. There's some additions which I can't obviously talk about which companies they are but we're seeing some pretty strong demand for two to four years out.

That's been going on for the last year or two. These are companies that are pretty much household names, big balance sheets that are looking at how they modernize. Just like Viacom did down in Hollywood where they brought all their divisions together and they in some cases they expanded various divisions, in some cases divisions were reduced in size but overall they wanted to get their people together, the same thing is happening in San Francisco, Seattle, San Diego and Hollywood.

Yes, to add on to what John said, Jamie, a lot of my job is involved in meeting with the senior levels of these companies, Fortune 500 companies. And specifically with respect to San Francisco, the key people are saying they are having trouble getting their real estate to catch up to their hiring plans. And these are large tech, large cap tech companies.

And so they are constantly looking at how to not only deal with the short term, which is where sublease comes into play, but how to deal with the long term, 2017, 2018. And I would touch on The Exchange actually as the only campus that's available in San Francisco in that timeframe. So we're poised really well.

If you look at us portfolio wide I would say the same thing is true. Seattle is on everyone's radar screen and so is Los Angeles in terms of -- and it all boils down to one thing: finding the talent and finding the facilities that help house that talent.

Okay, that's helpful. Thank you.

Brendan Maiorana, Wells Fargo.

Thanks. Good morning out there. John, there's lots of large, more mature tech companies in the Valley than not in the city of San Francisco.

Do you think you'll see or not that don't have maybe meaningful presence in the city. Do you think you'll see some or one of those tenants make a statement in 2016 and take that major space in the city?

I can't say whether it's 2016. There is a couple of major tech companies that are looking at some of the space that's under construction right now for major requirements. Whether they move on that this year or not I can't really tell you.

But I can tell you that amongst, within the comments that Rob Paratte made and I made to Jamie a moment ago about future requirements, there's some big plays that are going on right now that I think are going to be eye-popping. If they go forward they are going to be eye-popping for San Francisco and they are going to be eye-popping for Seattle.

It's very difficult to say when people -- think about it. If something doesn't -- look at our Flower Mart as an example.

We've got a couple of major companies that are looking at that, one of which has been looking at it for over a year, another one of which is looking at it right now. And they are trying to figure out how they -- what they are going to move into the city, what they are going to expand in the city in certain cases, how this all works. And I'm very encouraged by the table that we've set and the interest in the meal that's going to be served two to four years from now on our projects.

Time will tell. But I think you're going to see a continuation of the trend that we've seen over the last four years which is folks migrating to where the labor wants to live and play. And I can't think of two better areas than the city of San Francisco and Seattle.

And in both markets there is supply constraints, particularly in the city of San Francisco with Prop M. And we know what the preference is for these companies in terms of the type of buildings that they want. So more to come, but we're encouraged.

Okay, great. Then maybe, and somewhat related to that at The Exchange, so how is the mindset in terms of thinking about leasing that project between tenant credit, trying to find the right type of tenant that maximizes maybe the long-term value of the location and then just trying to put to bed the exposure in terms of getting leased-up as quickly as possible? How do you sort of think about those three dynamics?

Yes, I think that's a very, very good question, and obviously there have been a few analysts, some of whom have spoken on this call or may speak later on the call, that are contemplating the same kind of thing. I'm not interested in seeing deals done -- let's look at our job. Our job is long-term value creation, and I'm very mindful and we're all mindful of the pressure that people would like to put on us to just sign something up. But we have an opportunity to do some things that I think are going to -- if they happen, it will be eye-popping.

And that's our job is to make sure that -- I don't want a binary situation where we wait so long that nothing happens, but I don't think it's the case. If you look at what's happened since we started construction six months ago and since we announced the acquisition of the property roughly a year and half ago, and we had to go through a re-entitlement or a redesign and so forth, we've seen the market fundamentals improve significantly.

We've seen rental rates go up tremendously. We've seen vacancy rates go down. We've seen the available stock be absorbed and we're seeing buildings that are being built beyond this one that are generally a little bit different kind of building and not necessarily as sought after as the kinds of buildings that we're building there. So we think the market and the fundamentals have improved in our direction.

And when we take a look at some of the opportunities that we're working on, they have such long leases and such good credit that I think they are major home runs if we put them together. And if we don't, then we can go ahead and lease to any number of other companies, 100,000, 200,000, or 300,000 and make it multitenant, and I'm not worried about that. So I think we're doing the right thing.

I'm sure there are a lot of folks on this call that would like us to make an announcement, hey, we've signed this, we've done this or we've done that. I just want to put in perspective something that I think needs to be said. I mentioned in my comments that 80% of our development since we've been a public company in 1997, 80% of our development -- or 80% of that stuff has been leased by the time we completed construction. And we were up to 90% or 93% within a year thereafter to stabilization.

More recently I know we've had a lot of announcements at salesforce, at Dropbox and some others where we literally made the deals as we acquired the property or shortly thereafter. But Crossing/900 as an example with Box we were under construction for 10 months when we made that deal. In Columbia Square Phase 1 NeueHouse was 14 months after we started construction.

In Phase 2, Viacom was 14 months after we started construction and Fender 21 months after we started construction. And here in the city a couple of other data points is 222 Second Street which LinkedIn leased from Tishman Speyer, and that's roughly the better part of 0.5 million square feet, I believe that was a year after they started construction and 500 Howard which was also Tishman Speyer with a variety of tenants was about two years after starting construction.

Our own 360 Third Street building where it's a variety of tenants, Pack 12, etc., took about two years to lease up after we bought that building and repositioned it. And of course DIRECTV took the better part of two years to put together.

So I think what we're seeing with some companies is a more normal gestation period for a deal and that's just -- I'd like everything to be leased the day we announce it. It's just not ever happened that way on all projects but I'm very encouraged with where we're at and I expect that we're going to have very good results there. So sorry for the long answer but I want to put it in perspective.

No, that's great perspective. Just a last one maybe Mike Sanford if he's on. So it looked like Zenefits jumped into your top 10 tenant list.

So I think they may be had an expiration that was coming up. We are guys able to structure a longer-term renewal and expansion with them?

Is that for Jeff?

I think he was asking Mike that question, if Mike knows the answer.

Yes, so we've structured a couple of things with Zenefits as they've grown in the building. So I think that's what you're seeing.

Okay great. Thank you.

Vincent Chao, Deutsche Bank.

Good morning everyone. Just a couple questions here.

Just in terms of the tightness of the San Francisco market and understanding that it's not a lot of space relative to The Exchange but just curious given that tightness if you're starting to have any meaningful conversations on your 2017 maturities in the Bay Area?

This is Mike. I think what you've seen us do over time is be very proactive in looking a year or two out and trying to smooth out our expirations. We've done a good job of that in all of our markets but here in San Francisco as well.

So we're always having his conversations in advance. That's something that we do on a regular basis.

Okay and are you seeing increased demand from the tenants to get those done earlier?

Definitely, definitely. I think as John has laid out there's much more demand than supply.

And those tenants that are in existing buildings have the same problems as the ones that want to move into San Francisco. They are trying to protect their operations as well.

Okay, and then just turning to the investment markets John, it sounds like your commentary was fairly positive terms of not really seeing any changes in the strong demand and cap rate environment. But beyond cap rates, I was just curious if there's any other changes that you've noticed in the markets whether or not that's bid/ask spreads or time to close deals or anything like that that might be a shift from what you've seen?

Well, I haven't seen anything that's a deterioration. What we had seen is some products that frankly I was surprised at the values they traded for. Whether it was in San Francisco or LA some of the stuff in my view was not what I'd call core, client or core locations but not necessarily core that traded at really healthy values in my opinion based upon assumptions of I think the market is assuming that they are going to continue to be rental rates.

We underwrite everything. We buy very little, last year we bought nothing other than a couple of land sites.

So I'd say that some of the products that are coming on stream are great. Some of the products that are coming on stream are kind of -- Mike and Rob help me here.

I'd say kind of not first cabin, not necessarily best location and yet they are trading at pretty high numbers. We have seen a few projects that have come on stream and I've got to be careful because we probably have confidentiality agreements on a couple of these things.

We've seen a couple of things where the pricing was so over the moon for the asset or the location that they had to back up and ask for a different bid, a lower bid. But those are properties that in my mind it's like if somebody says they are going to sell you a Volkswagen bug for $80,000 you're probably not going to get a lot of bids. So there's some of that.

Okay. And then just from a foreign investor demand perspective, any changes there? And maybe specifically the Chinese investor, any pullback there in light of the government's efforts to stem some capital outflows?

We haven't seen anything. Obviously we don't, there's probably some better sources in that with East Hill and HFF and CBRE and whatnot. But we haven't seen any pullback.

To the contrary we're seeing a number of the foreign governments that are wanting to be in the cities that we're in. And I think Bellevue, Washington represents a pretty interesting story. The Chinese have become very big investors in that market on to-be-developed housing and I know there's been similar plays in LA.

But I can speak to whether it's changed up or down other than by what we've seen. And we're probably not the best one to answer that question in the broader perspective.

Okay, thank you.

Jed Reagan, Green Street Advisors.

Good morning, guys. Can you talk a little bit about your current views on sublease trends in the Bay Area? Is there anything that gives you concern and how those numbers are trending recently or how things might go from here through the rest of 2016?

Hey, Jed, it's Mike. Yes, so sublease space ticked up in the fourth quarter to about 2.2 million square feet which is just under 3% of the total market supply in San Francisco, so still a fairly healthy level.

I'll tell you since the end of the fourth quarter in January it has actually dropped back down to about 2 million feet. And two of the bigger chunks in there from the fourth quarter was the Dropbox space which we've talked a lot about. It's about 210,000 feet and they are rumored to be in leases for all of it.

And then the other what would be the Twitter space which is about 100,000 feet in there and LOI are leases for about 60,000 of it. So those deals happen, you're sort of in the mid-2%s of sublease space in the market which is very healthy across the board.

I think as we said it's actually a nice release valve for some tenants to be able to grow, some of the smaller tenants who want to grow in this space. The other thing that I would say is what's really important about the Dropbox space is it was oversubscribed with demand as soon as it came on the market.

And that's obviously because it's the kind of product that today's modern tenant wants. And as John mentioned there's not that much of that in San Francisco, let alone any of it available today. So when that product comes available it gets taken up fairly quickly.

Okay thanks.

And Jed, just there's been this space, and Rob help me on this, the space that I think Charles Schwab has had on the market for I guess probably a year now and that's roughly 300,000 square feet and it's all chopped up. It's in tiny little offices and so forth.

And to go in and sublease it I think the problem has been a lot of people that have been interested in that space I don't know where it is in negotiation right now but the rumor we get back from people is they looked at it but the CapEx they'd have to spend is too great given the length of the remaining term. So it's just not a plug-and-play.

Frankly, the sublease space, the other thing we're seeing with tenants is when talking to them is that in many cases this is as Mike points out a release valve. They are able to plan for their bigger requirement two or three years down the road by taking sublease space now and taking the pressure off.

One of the problems a lot of these companies have is they end up if it's not a sublease thing if they've got to go people like us are going to say we want a seven-year or a 10-year or a 12-year term. It's just an interim release valve people don't like to sign up for 10 years if they don't have to because they know they're going to get out in three.

Sure. Makes sense. Okay, thank you.

And as far as your plans for the shadow development pipeline, do you feel like you're still on track or are you rethinking the timing of any of those projects just based on some of the increased volatility we've seen in the capital markets or a sense that we're getting a little further along in the cycle or maybe just feeling like you've got a full enough plate as it is?

Well, yes. All those things are things we keep an eye on. What we're seeing on the ground and the demand we're seeing for a couple years out would suggest that we're probably going to get some of those projects off next year.

But I think this is the timing and everybody knows that's ever heard me speak knows that I have concern about the macro things that are going on in the world. We're not -- I mean we're definitely subject to all that stuff.

So yes, we're going to be conservative and make sure that we get a lot of pre-leasing done across the portfolio and make sure that we like what we're seeing in the tea leaves and then we'll make a decision. But I'd say the bias has become more conservative towards development, spec development given the factors that we're all concerned with around the world.

Okay. So still sort of executing on your business plan as you have been and moving forward for now.

Exactly. And for an example, look at One Paseo down in San Diego. That's about a $600 million project, about a $450 million new spend.

It's three phases of residential, one phase of retail and then the office space. The office space demand there, what we're really encouraged by with the heights and the deals that we're doing there is that people really love what's going to happen at One Paseo and we're getting very good rents in office space.

And in terms of the retail, you know we think we can get that substantially leased because it's so that's -- the demographics are so strong there, it's so underretailed. And the same thing with the apartments. So we're going to look at the different food groups, we're going to look at each individual market, we're going to look at the macro, we're going to look at how much we have leased or unleased in our core portfolio and how much we have leased or unleased in our development portfolio and make decisions based upon that but with a conservative bias.

Okay, makes sense. And just last one if I may real quick, in terms of the strategic sales transactions you talked about would you consider selling one of your development projects after stabilization, shortly after stabilization or even before the asset delivers and stabilizes but maybe after you've gotten a certain amount of pre-leasing done?

We consider a lot of different things. Remember, we have a Safe Harbor condition in REITs that prevent us from selling something, actively marketing it for two years following I think it's two years or one year. I think it's still two years following completion.

You can do ventures and move around it that way but we consider everything. As we've always said before we have -- I like optionality. We have options with regard to the resi or the retail.

Do we develop it and sell it, do we codevelop it, do we venture it once it's done? We have multiple options and we think that's a good place to be.

Okay, thank you for the color.

Dave Rodgers, Baird.

Just a little bit of follow-up on the asset sales, John, for you and for Tyler. And I guess Jed was getting a little bit of this.

But in terms of the asset sales $350 million to $650 million in the guidance for this year, how much of that is dependent on the new starts? And I guess the second part of that would be really where does that money end up going?

If you end up doing some larger venture, you hit the top end of your guidance for asset sales, are you feeling comfortable enough buying land, how much of that is going to go into development and how much of that goes into a dividend, etc.? As you sit here today I know it's not clear but just curious on your thoughts of being smaller maybe in the next year or so as opposed to continuing to grow?

Well, I think we continue to grow just by the stuff that we have going on and by growth in rents as another form of growth organically but that's a good question. And as you know, when you sell an asset if you sell it for $100 and your basis is $50 you have a choice.

You can 1031 or exchange it into a number of properties and spend at least $100 on those properties or you have some tax or you can pay a special dividend. So if our basis is $50 and our sale is $100 we have a choice. Do we trade into $100 worth of new stuff or do we distribute $50 as a special dividend?

And so all those choices are before us. We're not going to go buy something that we don't believe has more upside than what we're selling or where we can't make money off it.

Just to go park money I think we'd rather just do a special. So we'll see.

Okay and maybe a follow-up to that, I think you said 19 requirements in San Francisco over 100,000 square feet. If you looked at just new developments and the projects that you're working on, how many of those 19 would still be interested I guess in a new development project relative to others? And I don't know Mike or John if you have any color or clarity on that?

Yes, well remember those are current requirements and what's not shown in anybody's brokerage report is what people are looking at two to four years down the road and those are the kinds of things that would kick off new development. Most of the folks that are in the market for 100,000 square feet plus or minus now are in the market to fulfill a requirement now and they are having a damn tough time because most of the good space is gone.

Now there is space coming. We know that. There is salesforce and Block 5 and J.Paul's buildings, all of which are high-rises.

And most of the other stuff that can be developed, there's our Exchange for sure, and then the only other really shovel ready project of any magnitude particularly that's slower rise is 100 Hooper. So I think we're going to see some people step up for we've talked about The Exchange and speaking of Hooper that project is just so geared towards what the modern tenant wants in terms of floor plate size and lower scale, meaning not big tall buildings that I think those will all do very well. People are having a hard time right now finding space that works for them.

Okay, thanks John.

John Guinee, Stifel.

John Guinee here. Here's a question for Tyler.

When it's all said and done when you get through earnings season you're probably going to have the best fundamentals in terms of mark-to-market and the best fundamentals in terms of same-store NOI of anybody in the office space. That's the good news.

The bad news is CapEx releasing costs for you are about $7 a square foot a year and are not quite that high for others but are pretty high. When you do the math obviously a single-digit mark-to-market on releasing spreads doesn't cut it and make up for the CapEx spend. What do you think you need in terms of mark-to-market in order to justify the kind of CapEx spend that you and others are dealing with?

I'd probably have to do some analysis on that but obviously when we look at deals we look at net effective rent internally. So we need to make sure that your rent is covering all of your costs including CapEx.

And I'd have to think about what that spread of rent growth would be to come up with that number. But I don't know if you arrived at it needs to be double digit or not because we've had years where we didn't have double-digit rent growth and I think we still had positive net effective rent.

I think the other thing, John, that I mentioned, this is John Kilroy, is that what we've seen in our portfolio if you look at it in terms of particularly the core portfolio, we've done such a major transformation of converting what was I'll call the build space, your father's office space if you will, to the new modern space and that's much more plug and play. What we're finding there is that tenants that move into space that's already been converted have far less in the way of changes.

So that's the other trend that I think is going to begin to show up over time. And finally, with regard to our portfolio if you look at some of the stuff most of the stuff we've sold that we said is nonstrategic, we have lots of CapEx in that because as you've heard me say before the smaller buildings every time a tenant moves in, a major tenant moves in, they want to change the lobby and everything else. We don't get into that as much with the bigger projects.

So you're not doing much more in the way of full mahogany conference rooms?

Yeah, that doesn't happen. It doesn't happen.

As a matter of fact I was with somebody here, I can't say who it was, but one of the very major funding VCs of all these companies and one of the things we're talking about is how to simplify everybody's life with more plug-and-play kinds of space as opposed to everybody having their own designer and whatnot because they really do use the space very similarly. Change the paint color, maybe change the carpet, forget everything else.

Great, thank you.

John Kim, BMO Capital Markets.

Good morning. Thank you for reporting on a Monday instead of along with everybody else later in the week. I had a question on your San Diego dispositions and if you could provide some color on the cash gains of the IRs you've achieved?

Yes, Tyler, you want to go through that?

You're talking about the --

Intuit I think.

The Intuit transaction was a $260 million sales price and the basis is roughly $165 million. So there's a significant gain on that transaction.

Yes, but I think the IRR on that if you look at it unleveraged through ownership to point of sale was what? Michelle, you know that.

If you look at the IRR when we developed in 2007 to the sale is about 13%.

As a percentage of your NOI San Diego is about half of what it was a couple of years ago. Is there a target internally that you're looking to have San Diego?

Yes, a few years ago people used to say to me what do you think San Diego is going to be? And I said well if then it was X it's probably going to be with dispositions and development somewhere between 80% and 120% and not hard boundaries but of that X.

And obviously as we've expanded north and so forth and sold assets there it's diminished down to the levels you're talking about. I would think with the development that we have in Los Angeles, in Seattle, here in the city and then taking into consideration there that's probably going to drop to I don't know 20% or less. That's just a guess.

I think you're there already.

Yes, well that's why I said it's a guess. It could be -- I just don't know.

One thing I think that everybody must remember about Kilroy, and I love that chart which shows when we buy, when we develop, when we dispose of things, capital recycle, we're going to be very opportunistic. And that's what you've seen over the last couple of years.

We're going to take advantage of what the market permits us to take advantage of where there's inefficiencies and to fund that we like to use the sale of existing assets where we think we can get better growth by selling something and investing in something else. And we'll see.

San Diego is coming back. If you look at the rent growth in San Diego in Del Mar as an example in class A space year-over-year 2015 over 2014 was 18%. It's projected to be somewhere between 6% to 9% this next year -- this year, rather.

We think that the trends are coming along. It's been slower to get to a terrific rent growth. It's taken a number of years but it's getting there and there's very little new supply.

There's a couple of buildings that have been built that are pretty much spoken for. We have our little building there and then of course we have One Paseo. And ultimately we're going to have some other opportunities there.

So I can't tell you what is going to necessarily be. But it's an important part of the Company and as a plus or minus 20%, plus or minus 15%, sort of in that range probably.

Okay. I was wondering if you could comment on underwriting criteria in your markets? SL Green commented last week that for certain kind of product IRRs have changed and I'm wondering if you have seen that at all given the sensitivity in that market?

We haven't seen a tick-up in cap rates in our markets with the one proviso that if you are, as I commented earlier, if you're looking at a building that has a lot of CapEx or it's not as high quality then it's going to be priced presumably accordingly. But cap rates in San Francisco today for quality space are in the high 3s, the low 4s and IRRs are in the high 5s.

In Silicon Valley it's sort of the same thing, maybe IRRs 5 to 6. In Seattle it's cap rates of 4% to 5% and kind of a 6% range IRRs. In LA it's been anywhere from the high 3s to the low to mid 4s in cap rates and low to mid to high, depending on the product 6% IRRs.

In San Diego and in Del Mar it's sort of in a 5% range on cap rates. And IRRs sort of in the 6% to 7% range.

So that's kind of what we're seeing. And against that backdrop remember there's very little new supplies. There's pretty good demand throughout all these markets and we're seeing continued job hiring postings and increases so pretty good job growth. So I think it feels on the ground it feels great.

And can you remind us what target you have on development IRRs on an unlevered basis?

Yes, we talk more about ROCs and you kind of figure it out. Generally what we've been doing is somewhere between 7.5% and 8.5%, sometimes a little bit better across any particular project. And typically we get anywhere from 3% to 4% annual bumps.

Got it. Okay, thank you.

And John, this is Tyler. Just to clarify on the Intuit basis is $100 million.

Yes, that's what I thought because I knew that was -- it sounded a little high. I think our cost, original cost on the project was roughly $140 million, something like that.

Ross Nussbaum, UBS.

Hey guys. I just had to quick follow-ups.

It looks like one of your front page tenants group health corp got acquired by Kaiser Permanente. Any sense of what that ultimately means in terms of their continued occupancy when their lease is up and I guess when is that?

Are you talking about the group health in our Seattle portfolio?

Correct.

If it's them they've already announced that they have a campus that they're working on and constructing the probably will be out by 2019. But you know there's always construction delay so it could be longer. But we are aware of that.

And Westlake/Terry is such a great location that we're confident we're going to have it taken care of.

Got it. Okay, so it's a couple of years away.

All right, that's all I have. Thanks.

Derek van Dijkum, Credit Suisse.

Hi, it's actually Ian Weissman here. John, just given what your views are about cap rates and what you're seeing in the marketplace today, as you think about capital recycling at this stage of the cycle, what's your thoughts on just buying back stock given the value of where you currently trade?

I think it's an option. As you know in the last kind of an earlier cycle, we bought back stock and it's something that management looks at as a real possibility.

And what's the trigger point? So I mean your stock trades about a 20% discount to NAV.

You've been pretty active in selling assets in this market. You talk about cap rates being 4% or below. What do you need to see to be more aggressive in buying back stock?

You know I don't want to get into that right now, Ian. We've got a lot of things on our plate and we're going to see how this market goes and exercise what we think is in the best interest of shareholders in creating value. And we may have some special dividends.

We may have some stock payback. We might do some other things. We'll see.

Okay, thank you very much.

Michael Carroll, RBC Capital Markets.

Thanks, John, for the past several quarters you've indicated that the number of large tenants looking for space in San Francisco has far exceeded the available block. What options do tenants have that are looking for space but are unable to lease one of these spaces that are available? Do they look outside the market or do they just delay their leasing needs?

This is Rob Paratte. I'll try to answer that. I think it's twofold.

One, as both John and Mike pointed out earlier they are taking sublease space where they can get it and make a deal that makes sense, particularly in the two- to three-year time horizon. And I think other tenants, again these are large cap tech tenants, are looking at alternatives such as Seattle.

And there is also quite a bit of kind of what I would call reverse activity where you see firms that are based here in San Francisco also looking on the peninsula and South Bay. But to restate what we've said already, it's about talent and it's about being where the universities are and keeping these working groups contiguous and together. They don't want to split their creative groups up.

Okay.

One of the things that if I might just add that's really important, and this is a normal thing you hear from all the folks up here whether it's in the Valley or in the city, is proximity to public transportation, particularly if you think about the Valley Caltrain, how many stops is it from Stanford, how many stops it is and what the travel time is from the city.

There's a lot -- this is kind of creating havoc for some of the companies right now because they are trying to figure out how do they accommodate their expansions that are down the road little bit given what's available and not available. And that's why we're very took action based upon the trend we could see there to acquire the Flower Mart site and to acquire 100 Hooper because we think we provide some of the only solutions in the lowerized product that they like. But it is creating havoc.

But one thing they can't do or generally don't do is just move willy-nilly to someplace that might have land or buildings because it's all related to the availability of talent and where that talent wants to live.

Great. Thank you.

Manny Korchman, Citi.

Hey, John it's Michael Bilerman. I'm just curious, you talked a little bit about sort of the discipline that you have and the conservative tack that you're going to take sort of going down the road in terms of both selling, buying and developing. And I'm curious as you think about the tenant side of the equation, with the reduction in VC funding, with the difficult exit or the IPO market, have they approached, are they taking a change in discipline in terms of requiring more TIs or thinking about space needs differently or waiting a little bit longer to commit?

Has there been a change at all in how they're acting or in their discipline in terms of the marketplace?

Yes, you know, I would say that the jury is out on that, Michael. But we haven't seen -- we don't want to get into the position of being the capital source beyond what we feel comfortable with in normal TIs and so forth for some company that otherwise is not profitable or needs funding. We're not looking to be a VC if you will.

Rob, do you want to add any color to that what you're seeing up and down the marketplaces?

We're not seeing any extraordinary change. I mean tenants are aware of what the market conditions are in terms of what they're asking for and what they're likely to get. And I think other landlords are acting as we are which is as John said we're not going to be putting in a disproportionate amount of capital to get a deal.

Outside of TIs it's just the negotiations has there been any shift I guess is -- you're acting conservatively and under a disciplined manner because you see what's going on around you and that's by the very nature of the value you've created over time. I'm just curious whether we have a negative feedback loop going on with some of these tenants that are looking at the same things and would be concerned about the marketplace?

Yes, again I said I don't think we have enough input on that. We haven't seen it. We spend a lot of time, I personally spend a lot of time, I know Rob does too, spend a lot of time with the VCs and the angel investors and others that are involved that aren't always VCs that are family offices or others that are involved in a lot of these companies and a lot of those folks.

What we're getting is yes, you're going to see with value reductions there are some people that have been burnt where the Company went from $4 billion to $10 billion and slid to $6 billion or whatever it might be. Feel bad for those investors, if they're tenants of ours if they are okay, if we are okay at $4 billion we're certainly okay at $6 billion and we didn't underwrite $10 billion.

And what does all this mean? I don't know.

But I think the big thing that I would ask everybody to look at is if you look at VC funding right now, and as I mentioned in my comments, VC funding, the reduced VC funding in the fourth quarter was still like 1.5 times, 2 times what it was in 2010, 2011, 2012, 2013. And those were very good years with much higher vacancy rates.

When we moved into San Francisco in May, late May or early June 2010 if my memory serves me right, so maybe a little slack on this if I'm a few basis points off one way or the other, we were roughly 17% vacant north of market and 14% or thereabouts vacant south of market. South of market today is essentially zip, no vacancy. So I would contend and I think others have written articles on this that we don't need to have the level of IPO or VC funding that we've seen over the last few years given the vacancy rates to still have a very healthy office market.

I mean obviously we'd like to see more and everything is great but I personally don't like overheated markets. I like markets that are good and getting better and I think that's kind of what I'm seeing now.

Projected rental growth in San Francisco by the top brokers right now and Silicon Valley is somewhere in the neighborhood of 5% or greater and that's an average rate. So better buildings are going to do better. What we've always operated on is to make sure that we stay true to location and physicality so that we have the product that most people want and that's good in any market.

But in a defensive way it's the kind of space that people want to be in. So I don't want to ramble on any further but I feel like right now people are being very, the VCs and so forth, are spending a lot of their money on third and fourth stage as opposed to first stage. That's not all bad.

Some companies will fail and deserve to fail. And let's just be real honest about this, the nature of technology is that it's rapidly evolves or increase the revolution and it sometimes that obsoletes other things. Look at some of the hardware providers and whatnot.

And while that's a tough thing on any particular company, if you look at it and the kind of hiring characteristics and so forth that we're seeing in most of our markets if a company is going to lay off 400 people, those 400 people are going to get hired by somebody else because that's just the nature of the labor market we have. So I view that there is a natural sort of selection and we'll see some failures, we'll see some companies that don't have the expansion plans they had.

And I take this back to one of the reasons I really like what we're seeing and working on at The Exchange is because I think the quality of tenant there is so terrific that I think at a time where if there is less, more confusion in the markets just do business with really solid companies when you can, do solid lease terms, don't do silly things, don't underwrite them more aggressively, don't put up more TI, be more conservative. And that's the way we're operating our Company.

All right, okay, thank you.

I would now like to turn the call back over to Tyler Rose for closing comments.

Okay, well thank you for joining us today. We appreciate your interest in KRC. So long.