Kilroy Realty Corp (KRC) 2016 Q2 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Q2 2016 Kilroy Realty Corp. earnings conference call. My name is Ashley and I will be our operator for today. At this time, all participants are in listen-only mode and later we will conduct a question-and-answer session. (Operator Instructions). I would now like to turn the call 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 the 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 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 second quarter. Jeff will discuss conditions in our key markets. I will finish up with financial highlights and a review of our updated earnings guidance for 2016. Then we will be happy to take your questions. John?

Thank you Tyler. Hello everyone. Thank you for joining us today. We had a very productive second quarter and a strong start to the third quarter. We signed leases in our stabilized portfolio during the quarter, boosting occupancy above 95%. We generated another quarter of strong financial results with same-store cash NOI up 12.4%. We increased our dividend 7.1% to an annualized rate of $1.50 per share. We acquired a fully leased office property in Mountain View with excellent incremental development potential. We completed construction on the residential portion of our Columbia Square mixed-use project in Hollywood, where leasing is ahead of schedule both in terms of rate and timing. In our current near-term development projects, we are having meaningful discussions and trading paper for large blocks of space at The Exchange in San Francisco, at 100 Hooper in San Francisco, and at 333 Dexter in Seattle, and expect to see significant leasing activity this year. We received final title approvals for our One Paseo mixed-use project in Del Mar and for our 333 Dexter project in South Lake Union. We sold our three remaining land parcels in Carlsbad and two small buildings and a land parcel in Sorrento Mesa. And we are in final documentation on the formation of a joint venture with a large sovereign wealth fund. Let me start there.

Given that we haven't yet closed and because we are still under a confidentiality agreement, I can't go into too many specifics, but what I can say is the following. We will raise approximately $450 million in proceeds, net of some existing debt, through the formation of a joint venture in which the sovereign fund will take a significant minority interest in two of our SOMA assets. The closing is anticipated to occur in two tranches with one of the properties closing this quarter and the other property closing in the fourth quarter. We see this as a terrific opportunity to establish a strategic relationship with a world-class organization that shares our interest in long-term value creation as well as raise capital to fund our near-term developments. This transaction is a reflection of strong and enduring interest among sophisticated global investors in West Coast real estate. Market strength is apparent given outperformance and job creation, a significant increase in Bay Area BC funding back at mid-2015 levels, and healthy commercial real estate fundamentals.

We saw these same market factors positively impact our second-quarter results. In operations, we signed new or renewing leases on 266,000 square feet of space in our stabilized portfolio at rents that were up 40% on a GAAP basis and 19% on a cash basis. We also have approximately 515,000 square feet of letters of intent. Approximately half are related to the stabilized portfolio and the other half are related to development projects.

In development, we remain on budget and on schedule with our three projects in lease up and one project under construction. First, our Columbia Square mixed-use development project in Hollywood, we completed construction on the $160 million 200 unit residential tower and moved the project into lease up during the quarter.

Leasing has been very strong. We leased 22% of the units within one month of opening. We project stabilization in the summer of 2017.

Second, also at Columbia Square, we are lease up on the 370,000 square feet of newly constructed office space where we are 80% committed and expect to be fully committed by year-end. Fender Musical Instruments recently took occupancy of its global headquarter space and Viacom remains on schedule for occupancy late in the fourth quarter.

The third project in lease up is the Heights at Del Mar, a 75,000 square-foot building located in Carmel Valley, Del Mar area of San Diego immediately adjacent to our One Paseo mixed-use project. We have and LOI for approximately one-third of the project. And we have one project currently under construction, The Exchange on 16th, our 700,000 square-foot, approximately $500 million office campus in the Mission Bay area of San Francisco.

As we have shared with the market, we have been pursuing two large tracts -- or two leasing tracts for the project, one with a large organization interested in the entire campus and the other a multitenant strategy. We had thought, by the end of June, the first tract would have resolved itself, but given macro political issues and vacation schedules for the decision-makers, the tenant remains a potential but less likely option. As a result, we have redirected our efforts towards a multitenant strategy and are now trading paper with a handful of major tenants within the technology, life science and healthcare industries, each interested in blocks of space in the 100,000 to 300,000 square foot range. As we have communicated before, we won't deliver the project until the end of 2017 and remain confident that we will have it substantially leased well before completion.

That brings us to our four near-term development projects where we have made significant progress. Earlier this month, we obtained final approval of entitlements from the City of San Diego for our Del Mar One Paseo project. The fully approved project now includes a total of 1.1 million square feet, including approximately 600 residential units, 265,000 square feet of office and 96,000 square feet of retail space. The total estimated investment is approximately $625 million to $650 million with $425 million to $450 million of incremental spending which will be phased. Given the strong demand and limited competition for retail and residential components of the project, we plan to start construction in the fourth quarter on the first phase, which will consist of the infrastructure for the entirety of the project as well as approximately 235 apartments and substantially all the retail space. We expect the total spending for this first phase to be approximately $150 million over the next 18 months. Our current plan is to construct the office component once the retail is up and running.

At 333 Dexter in South Lake Union, we also just received final entitlement approval. We plan to develop approximately 660,000 square feet of office and retail space for a total project investment of $380 million. Detailed discussions with prospective tenants are expanding as this market continues to outperform.

In Hollywood, we continue to make progress on final entitlements for The Academy. Given our success at Columbia Square and the strength of the Hollywood market that is benefiting from the convergence of technology and media, we continue to target early 2017 for the start of construction, subject to market conditions.

And finally, at 100 Hooper in San Francisco, our $255 million fully entitled 400,000 square-foot office and PDR project, we have said that we won't start construction until we make progress at The Exchange or at Hooper itself. We are seeing increased interest in Hooper and could have more news on the pre-leasing in the very near future.

All of our future development plans remain contingent on where we stand on leasing across the Company and will be based on strong market fundamentals and tangible demand.

Also during the quarter, we made one acquisition, completing the purchase of a 114,000 square foot 100% leased office building in the Mountain View submarket of Silicon Valley for $55 million. The initial return is 6.2%. We view this opportunity as a covered land play that carries the investment of a strong return while we look to create significant value through entitlement and new development over time.

Let me finish with a recap of recent activity in our capital recycling program. During the quarter, we completed the sale of our last three land sites in Carlsbad. The three parcels aggregate about 25 acres, and we sold them to two separate transactions -- two separate buyers for gross proceeds of $14.9 million. In addition, just last week, we completed the sale of two small office properties and a land parcel in the Sorrento submarket of San Diego. The transaction generated gross proceeds of $49 million.

Year-to-date our capital recycling efforts have now produced just over $330 million of completed transactions. Adding in the projected $450 million net proceeds from the joint venture, we are now projecting about $800 million in total for the year or about $300 million above our prior midpoint. In short, we are well-positioned to fund new development while maintaining a strong and flexible balance sheet.

To wrap up, let me summarize our market position. Our vertically integrated platform with a long history of development success has resulted in us owning one of the highest quality, youngest, and most sustainable portfolios in the country. Our stabilized portfolio and recently completed developments are generating significant cash flow that has resulted in terrific same-store results and a recent dividend increase. Our disciplined capital allocation decisions have resulted in significant value creation while maintaining one of the best balance sheets in our sector.

We have a team in place that has deep knowledge of our local markets. We recently hired Tracy Murphy who will help the team with life science leasing and future opportunities. We currently operate in three of the top four life science markets in the country and view life science as a natural extension to our platform.

We are continuing to set the table to create significant value downstream through the acquisition of two terrific covered land opportunities, approvals after a long battle at One Paseo, entitlement success of our 333 Dexter project that couldn't really have been scripted better given the strength of the South Lake Union market, the positioning of The Academy in the heart of Hollywood that will follow the success of Columbia Square, near-term life science re-entitlement approval at our 9455 Town Center project in the UTC market of San Diego, and longer-term through the development of the Flower Mart project.

We have created a self-funding mechanism for our existing and new development through a successful capital recycling program that will result in the sale during 2016 of approximately 10% of our enterprise value and leave us with one of the youngest and most sustainable portfolios in our sector. The $850 million of new development that we will deliver in 2016 will generate annual EBITDA of approximately $63 million on a stabilized basis, 85% which is relative to office and 15% which is related to the residential.

And finally, we operate in the strongest submarkets in the country. While it rarely happens, I agree with Governor Brown when he recently said that most of what makes America great is happening in California. California is leading the world in globalization and innovation, and ranks seventh in the world's economy from a GDP perspective. Four of the world's top 10 largest companies are based in California, and no state comes close to California in terms of sustainability initiatives. The San Francisco Bay area is the world leader in technology and second in life science, and Hollywood is the entertainment capital of the world. I also want to point out that Seattle has many similarities to California, what I just mentioned.

That completes my remarks. I'll turn the call over to Jeff for a closer look at our markets. Jeff?

Thanks John. Hello everyone. As John noted, market fundamentals remain strong across all of our real estate markets. According to JLL, West Coast job growth outpaced the rest of the nation by almost 65% and our markets commanded a 17% premium in rents compared to the national average.

In the San Francisco Bay area, market fundamentals continue to trend higher. Net absorption of the City of San Francisco was positive, 372,000 square feet and rental rates increased 1.5% from the prior quarter, bringing the year-to-date increase approximately 6.5%. Class A direct vacancy was 3.2% in San Francisco's SOMA district, and 5.5% in the South Financial District. In Silicon Valley, class A direct vacancy was 9.1%. We are currently 99.5% leased in the Bay Area and our in-place rents for the region are approximately 33% below market.

Seattle continues to see strong demand from large tenants expanding their footprints in search of talent. Class A direct vacancy rates in our primary Seattle submarkets of Bellevue and South Lake Union were 10.7% and 6.8% respectively. Our Seattle portfolio is currently 98.2% leased and our in-place rents are approximately 5% below market.

In San Diego, rent growth increased 2.6% quarter-over-quarter and 9.2% year-over-year. Net absorption was negative in the second quarter driven largely by QUALCOMM's recent move outs. However, year-to-date net absorption was 615,000 square feet, 25% higher than last year. In Del Mar, class A direct vacancy was 12.9% and in Sorrento Mesa, two-story corporate office vacancy was 5.8%. Our San Diego portfolio is currently 91.5% leased and our San Diego in-place rents are approximately 8.5% above market, driven by a few large leases.

Los Angeles real estate markets continue to benefit from dramatic growth in a wide range of a creative industries from film, television, gaming and theme park design to fashion, food and toys. These industries produce more jobs in Southern California than in any other market in the country. The impact is evident on rents and vacancy rates, especially in the popular submarkets of West LA, Playa Vista, Beverly Hills and Hollywood. The class A direct vacancy rate in West LA was 12.5%. Across our Los Angeles portfolio, we are now 95.5% leased and our in-place rents are approximately 16% below market.

Overall, for our stabilized portfolio, in-place rents are approximately 17% below market. For the remainder of the year, we have approximately 273,000 square feet of expirations. As we look out to 2017, we have just one lease expiration greater than 100,000 square feet and 40% of the 2017 expirations are in Los Angeles where rents are approximately 25% below market.

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

Thanks Jeff. FFO was $0.86 in the second quarter, including $0.01 of acquisition related expenses. Same-store NOI continued to grow in the second quarter, up 12.4% on a cash basis and 3.2% on a GAAP basis. This was driven by higher rental rates and the expiration of free rent, partially offset by lower than average occupancy.

Subsequent to the end of the quarter, we paid down our credit line completely with the proceeds of the Intuit campus sale. These proceeds had been held in a restricted cash account pending a potential 1031 exchange. Now that we are not using the sale proceeds for an exchange, we expect to make a special dividend at the end of the year in $160 million to $200 million range. We now have full availability on our $600 million bank line and approximately $80 million of cash in the bank.

Based on strong projected 2016 FAD coverage of approximately 65%, the Board decided to increase the dividend 7.1% during the quarter. We will continue to evaluate the dividend annually and balance the need for capital to fund development with tax requirements and stronger dividend coverage.

Now let's discuss updated 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 uncertainties in today's economy. Our current guidance reflects information and market intelligence as we know it today. Any significant shifts in the economy, our market's pent-up demand, construction costs and new office supply going forward could have a meaningful impact on our results in ways not currently reflected in our analysis.

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 updated assumptions for 2016 are as follows. As always, we don't forecast any potential acquisitions or acquisition related expenses. We anticipate remaining 2016 development spending to be approximately $125 million to $150 million. Last quarter, we increased our 2016 same-store cash NOI growth guidance to a range of 7% to 9%. Given continued strong results, we are again increasing our guidance and are now in a range of 9% to 11%. We remain comfortable with the year-end occupancy number at the high end of our previously reported 94.5% to 95% range.

In terms of capital recycling, last quarter we projected capital recycling proceeds would be in the $350 million to $650 million range with a midpoint of $500 million. As John mentioned, with the recent sale of several small San Diego assets, combined with the anticipated joint venture, we now expect total proceeds for the year to be in the $800 million range. While these proceeds have effectively positioned us to be able to fund our near-term development through the end of 2017, it will be somewhat dilutive in the short-term.

So, in terms of earnings guidance, last quarter we provided a 2016 FFO range of $3.36 to $3.50 per share with a midpoint of $3.43 per share. We had better than projected second-quarter performance of about $0.01 a share, which was offset by $0.01 a share of acquisition related expenses. The joint venture transaction will be about $0.03 a share dilutive over the remainder of this year. Taking all that into consideration, our updated 2016 FFO per share guidance range is $3.36 to $3.44 with a midpoint of $3.40 per share, which is effectively $0.01 higher than last quarter's midpoint adjusting for the joint venture and the acquisition related expenses.

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

(Operator Instructions). Jamie Feldman, Bank of America.

Great, thanks. Can you give a little bit more color on the comments at The Exchange in terms of the single tenant versus multiple tenant? And then also does it change your underwriting yield or your projected yield at all, the different types of configurations you might have?

Let's deal with the last question first. We anticipate beating our underwriting yield. The bigger deal would have been an improvement to our underwriting, a more significant improvement. In terms of color, Rob, you're dealing directly with that, so why don't you handle that question?

Consistent with NAREIT and what we told you back then, we are in several negotiations I guess with tenants ranging from 100,000 to 300,000 feet each and they run the gamut from life science to technology, and there are quite a few. And actually there was a substantial uptick in activity in Q2 2016. So, we are fully engaged with multiple tenants and expect to have some good news here shortly.

Okay. Are they interested in the same spaces or does everyone kind of fall into place well within the building?

The building is large enough that we can move and fit the pieces of the puzzle together. Some of them have growth plans, and so that's where it gets a little trickier trying to accommodate the growth of some of these fast-growing companies we are talking to.

And then what are your thoughts on -- I'm sorry.

Just a little more color on that. We have four buildings in that project that are side-by-side, a six-storey, a 12-storey, a six-storey and the 12-storey. And then we can connect them horizontally on three super floors. So what we are going through is the allocation between various tech tenants and life science tenants that we are working with. And we built the building to accommodate life science tenants when we designed it and engineered it and the foundations and so forth, so we have that capability of going both ways. And we are looking at a pretty tremendous credit profile for both big tech and life science.

And what does that do to the incremental cost?

The cost as projected, to the extent that we -- I think we have enough in our budget to accommodate the combinations that we are talking about, and we forecasted a fairly significant amount of contingency. So, I think we are in good shape.

Okay. And then just last question from me, the 100 Hooper, it sounds like you are seeing even more demand there. Just latest thoughts on timing and how soon we might see a lease there.

Yes, we are negotiating LOIs on a substantial percentage of the project with high credit tenants, which, if consummated, would trigger the commencement of construction later this year. So the timing -- I think if things fall into place as we anticipate they are, and we are in very detailed negotiations, I would expect that we would have a sufficient amount leased to trigger the construction of that project so that it would start in the fourth quarter.

Okay. And then sales proceeds to fund development through 2017, does that include 100 Hooper or that's incremental?

Tyler, do you want to go over the funding?

Yes, that includes the assumption that we start all of our near-term development. So if we don't start it, we have even more capital.

Okay, great. Thank you.

Blaine Heck, Wells Fargo.

Just a couple of follow-ups on that stuff. So besides the single kind of user at The Exchange, can you talk about maybe the aggregate size of the pipeline of prospective tenants you guys have there, and how kind of that compares? I think you said it was up from earlier this year, but can you put some numbers around that?

Yes, we can. I want to be a little careful about -- we have NDAs, so we can't talk about specific tenants, but it's broken down between tech and life science. And within that life science category would also be medical uses. And in aggregate, it's somewhere between 2 million and 3 million square feet that's currently foot-fit. Jamie had asked the question earlier about is some of that space competing. Well, obviously it is because we only have 720,000 feet.

Sure, that's helpful. And then just one more quick follow-up on Jamie's question. So specifically on 100 Hooper, what's kind of that sufficient amount of releasing that you are talking about, what's kind of the hurdle rate that you would be kind of comfortable going ahead with that, especially if The Exchange were to kind of remain at 0%?

I think if we get 50% with what we are seeing, that would be very -- that would trigger it. We might do considerably better than that.

Okay. And then the last one from me, John, recently there's been some high-profile M&A in the tech and TAMI sectors with Microsoft and LinkedIn and now Verizon and Yahoo!. I guess generally just how do you see M&A kind of affecting the leasing conditions in your markets, especially San Francisco and maybe LA? And then more specifically to LinkedIn, your number one tenant, are there any specific pockets of space that you would expect them to give back?

First, to the last part of the question, no. Remember that Apple occupies most of the LinkedIn leased space. They occupy two-thirds of it.

Okay.

I don't see anybody giving back space. And if they did, the rental rates at which we did the deal are significantly below, very significantly below, current market. But they don't have the right to give back.

Okay. Thanks for the color.

Rob, do you want to deal with the M&A part of it?

Sure. Just a little more color. I think the Yahoo!/Verizon M&A is interesting in that the core business of Yahoo! is really the Internet related portion of it. And so I think, in that case, there may be redundancy, whereas I think you look at LinkedIn and Microsoft, Microsoft bought LinkedIn for a reason. It was for the talent that LinkedIn has. And what we are hearing both from LinkedIn and outside is that there are no plans to shed space. In fact, they continue to build out TIs in the spaces they have that weren't built out.

Manny Korchman, Citi.

Good morning and afternoon everyone. Tyler, if we look at the disposition guidance, and correct me if I'm wrong, if we look at that on a like for like basis versus where you were last quarter, are you actually planning to sell less but now you are incorporating the JV? Am I thinking about that correctly?

We had a range last quarter of $350 million to $650 million with a $500 million midpoint. We hadn't sold the $500 million as of last quarter. We had done the Intuit transaction, and one land sale at that point I think. So we've now done $340 million or so, so we done more since last quarter of actual sales. And then if you just take the $350 million and add the $450 million, you get to the $800 million.

So there are no other anticipated dispositions beyond the JV?

There may be a very small building that we are working on, but basically no. I think we are saying we are good where we are this year on disposition.

And then as you've had these discussions about the JV, have you guys or have the Capital Corners expressed interest in other JVs, and where do you stand on that? And sort of given your funding needs are recovered, does that sort of wane your interest a little bit?

No, we are not going to get into specifics, because we are tied up in knots on confidentiality agreements, and this is a one-off transaction involving two properties. But what has been part of our strategic desires and theirs, which matches perfectly, is to have a relationship where, when you have something you may want to venture, whether it is existing product or perhaps a larger transaction or a major development project, it's nice to have that opportunity in the quiver, so to speak. So that's strategically the biggest reason why to do this. And it's a well-known entity that has a long bit -- a long history of successful transactions with others and so forth. So we are very comfortable with our future partner.

That's it for me. Thank you.

Craig Mailman, KeyBanc Capital Markets.

(technical difficulty) AFFO dropped on a go-forward basis, is obviously a lot of these assets have higher CapEx than the rest of your portfolio. Historically, you've been running call it a $0.60 drop between FFO and AFFO. How should we think about that trend into the fourth quarter once these assets are out? How does that narrow on a quarterly basis?

You are right. It's going to narrow. Mike (multiple speakers)

What's happening here is someone is talking on two different calls. Operator? Operator? (technical difficulty) We have another conference call on the line (technical difficulty) so instead of $0.15 a quarter, down $0.10. And arguably, the sales if you're selling $1.3 billion in let's call it the high 8s% and paying down debt, a mix of line and other debt --

(technical difficulty) conference call that all of a sudden has some other conference call on it. Operator?

That was Craig's line. His line is open. That was his line.

Oh, come on. Okay. Can we turn the line off. You can ask us a question Craig, or are you asking it of somebody else? Go to the next one please.

Nick Yulico, UBS.

Thanks. I just wanted to go back to when you were talking about earlier with over 500,000 square feet in LOI right now with half in development. Is any of that which is in development relating to The Exchange right now?

No comment.

Okay, so it could be various projects but not necessarily -- but maybe The Exchange too?

We have confidentiality agreements. We want to give people the information we are permitted to give, but we can't give information that we are prevented to give. So, I would hope that we would be able to add clarity to that fairly soon.

Okay. I wasn't asking for a name of anything, just whether any of that half that you said is in development is actually pertaining to The Exchange or not.

It pertains to properties in San Francisco. I'll give you that. Not including the Flower Mart.

Okay, fair enough. And then just turning to the mark-to-market on lease commitments this quarter, I think it was 7%. It seemed a little bit low. Was there anything that was driving that a little lower than usual?

I'm sorry. Tyler, did you get that? The first part of the question cut out. I don't know what's happening with our conference call provider, but I'm not impressed. I'm not speaking about your question, just about the fact that I couldn't hear the first part of it.

I think if you look at the -- that was a commenced number. If you look at the executed, which is theoretically at a later time, those numbers that Jeff went through are back up. I don't think there was anything executed that is indicating a trend if that's what you're getting at. It was 19% on the executed, 7% on the commenced.

Okay. Just lastly, going back to The Exchange and you've been pursuing a couple of options, looking at the big tenant versus multitenants, did the fact that you were looking to possibly do something with the big tenant for the whole building, did that delay any of the leasing of a multitenant building, or was it other factors that maybe tenants you're talking to in a multitenant building have other options they are looking at, buying leases out in existing buildings which is sort of delaying some of the leasing?

I'm not sure about the last part of your question, but obviously we've been juggling a lot of tenants over the course of the last year, and there has been a rotation, if you will, of some of the people that are now in the queue versus some that were in the queue a year ago. So we may have lost a transaction or two in the 100,000 foot or 200,000 foot range of last year, but we have plenty of runway in which to get the project leased. The rental rates have been going up in the market, demand has increased, and we'd love to do the big deal, but with the clowns that have to make a decision now being all on recess, as we said at NAREIT, that if we didn't hear by the end of June an affirmation of the transaction, the big deal, that we would go multitenant. And that's what we are doing. Now, the big deal could still come back before we sign the others, but we are not holding our breath for that simply because the entity that has to decide is one of the most dysfunctional entities in the world, and you would probably know who I'm talking about.

Thanks John.

As evidenced by some of the people that are now in the political arena. No further comment.

John Kim, BMO Capital Markets.

I was wondering who you thought would win the presidency.

Oh my God. I was hoping for Michael Bloomberg, but he chickened out I guess. You know me, John, I despise politicians in most cases. Generally, I like some governors and I like mayors because they actually get something done, and they generally are held more accountable. I'm not impressed with the current lineup, but my vote doesn't really count because I live in California.

Okay. Moving to One Paseo, can you just remind us how you plan on positioning the retail and multifamily component of it, and if you are going to do this entirely on balance sheet?

Well, we obviously have options (technical difficulty) on balance sheet first phase of it. We've had all kinds of people come to us that are retail companies and apartment companies and so forth wanting to venture, or wanting to buy out one of those phases or elements.

Right now, we think there is significant value creation by moving forward with the infrastructure and the first phases. The first phases are retail, well, it's almost entirely all of the retail, it's a few thousand feet short of the total, which is just under 100,000 square feet. And it's very well received by the folks we've been talking with as prospective tenants, as well as the marketplace, and obviously had to be vetted by the city and by the community and so forth, so we know it's going to be very successful.

And then the apartments are roughly 620 units or 610 units. As I mentioned, we're going to start the first phase, which is 235, and then roll into the second and third phases as appropriate. And the office component will be about, what is it, 275,000 feet, roughly as well. And we will do that once the retail is done, and the site is cleaned up and so forth, again, subject to the market. So at this point, we are contemplating doing it on balance sheet, but we have options. We can venture, we can sell, we can do different things.

And as far as infrastructure, do you have the personnel in place to handle the retail and multifamily components internally?

Oh yes, we do.

Okay. Overall, your vacancy rate is very low, but you have a fair amount of leases expiring next year. Where would you like to see that figure heading into 2017? And can you provide a mark-to-market on the 2017 leases?

Tyler?

This is -- for the 2017, we've got 9.3% of the portfolio rolling, which is very measurable. Mark-to-market, we are basically 17% under market for next year as well.

Okay. And then finally, John, you mentioned a few times in your prepared remarks how young your portfolio is. Is there a specific range or target that you have?

No, we consider a property, if we bought a property -- I mean one of our buildings, 250 Brannan Street is 110 years old, but we consider it new because it was totally redone.

But what we think is really important, and we think the investment community should really take a look at this is that we have a very young portfolio. It's been very modernized. Much of it is brand-new. It comports to the way people use space, to the densities that people use the space, to the mechanical needs they have, etc. And we have been the leader two years running in North America across all the different real estate types and sustainability. And increasingly people are focused on that kind of space. And so we think it has a lot less CapEx and we think it has higher demand, and we think it will achieve higher rents than a lot of the existing stock, which, by the way, for an example, if you look at this vacancy rate here or sublease space rather in San Francisco, which is roughly 2 million square feet, half of that is north of Market in fairly obsolete space.

So we know the kind of product we have is and will continue in our view to be more successful than older buildings which have more CapEx and have -- and don't have the capacity to handle the higher density. So we think that -- I think our average is about -- I think our average age is 10 years in our portfolio. I'd put that against anybody else in the country.

Thank you.

Steve Sakwa, Evercore ISI.

Thanks. Good afternoon or good morning out there. I guess John, first question maybe for you or for Jeff. Just in kind of your broad discussions with tenants, I'm just trying to understand kind of their psychology around kind of space needs and how that might have changed just given kind of what's going on in the world and in the economy. Are they kind of more optimistic, less optimistic? Just kind of what's the general tenor of the tenants today?

We are seeing significant numbers of expansions throughout most of our markets. And a lot of that is not only now but two or three years out. If you look at Seattle, maybe we'll just roll through the different markets real quickly, and kind of what we are seeing. But just a big picture, I'd say the markets feel much stronger today than they did at any point earlier in the year.

Definitely. Steve, in Seattle, if you just -- and most of this is public -- if you look at who is looking in the market now, there's Apple, there's Amazon, there's Facebook, Uber, Google, Salesforce; all of them are looking for space. They take an initial premises. They are looking for more. And I mean I would say every two weeks there's a new name on the list.

And I think another part of your question is what we are also seeing in terms of sentiment from the tenants side is they are making the capital commitment in their premises to deliver space that helps them retain, hire and keep the best and brightest employees. So we see them spending money on tenant improvements and all sorts of employee benefits. That hasn't scaled back. In fact, I'd say it's probably ramped up.

And you talked about Seattle, --

You could go through -- I'll talk about a couple of cities. San Francisco, same thing. Big tenants in the market, Airbnb, again Facebook in the paper yesterday, Pinterest, Amazon, Apple again. Mike, do you want to touch on Peninsula?

Sure, very similar in Peninsula and the Valley. Steve, I think 13 straight quarters of positive net absorption in the Valley. Google just took another 600,000 feet in Sunnyvale, LeEco bought the Yahoo! land, which they plan to build 2.5 million to 3 million square feet. QUALCOMM did a lease in San Jose for 350,000 feet. So I'd say, across the board, very similar. And then maybe David, do you want to take LA?

Yes. Similar, echo the comments. Media and entertainment continue to grow. When you look at Playa Vista where it's rumored Google is going to take the balance of 600,000 feet additions, Tishman's building and that would suck up the entire square footage in Playa. You roll through Santa Monica where rates continue to move up for the smaller guys. West side, you have 12.5% kind of on the paper vacancy, but probably half of that space is probably not functionally -- it's functionally obsolete, probably never be filled.

We are seeing the entertainment and media companies, Warner Music, HBO, Showtime, all consolidating. Hollywood is seeing a lot of activity on the organic growth of smaller guys that are expanding. We don't have a stitch of space left in 6255. And we've got a lot of activity on the balance of Columbia from tenants to 15,000 to 25,000 and feel confident by the end of the year we will be buttoned up there. so I think the sentiments up and down the coast are similar.

San Diego, kind of finishing the thought, Steve, we have Intel down there looking for a large amount of space, Northrop Grumman, CareFusion. So as everyone has said, there's a lot of activity.

And I think the one thing we didn't touch on his life science in each of these markets. And that's why having Tracy Murphy on board is going to be a real uptick for us in terms of the demand that's coming from these knowledge communities like Mission Bay as a result of big pharma and collaboration with public institutions like UCSF. It's just going to continue to grow. You're seeing it in Cambridge; you are seeing it here on the West Coast. So I think the trend we see is continuing.

Okay, that's helpful. John, I guess, as it relates to the exchange, I'm certainly not asking for names of tenants, but when you just sort of look at who you are talking to today, are those tenants that are already currently in sort of the downtown or Mission Bay area, or would you say those are tenants relocating with a first-time presence in the downtown area?

A combination, a combination of both.

And I guess presumably it's expansion space for all of them, or as opposed kind of musical chairs and relocating from other areas?

Yes, it's -- again, I've got to be careful because of confidentiality agreements, but there are a number of people that have space here that need to grow beyond their existing premises, so it's expansion. We are seeing that at both the projects we mentioned that are one under construction at The Exchange and the other at 100 Hooper. And we are also seeing folks that haven't traditionally been in San Francisco that are technology companies that are big, big tech, that want to be here.

So we think we are in the catbird's position in some respects because, if you think about it, Kilroy, between The Exchange, 720,000 feet, and 100 Hooper, 400,000 feet, controls the lion's share of available low mid rise space that is generally the most sought after by those kind of companies. So we think we're going to, based upon the negotiations that we have going on right now, we think we are going to do very well on both those projects, and similarly with 333 Dexter up in Seattle because it's exactly the same phenomenon.

Okay. I guess that was my last question which you kind of touched on. But 333 Dexter is a large project. Do you envision that going to one tenant, or do you envision that being a multitenant? And what level of preleasing would you want to see in order to kick that off if it's not a single user?

Yes, well, I don't want to get into too much detail because all of the tenants listen to everything, but we've got a couple of big users that are interested in substantially all of the property right now. We could do multitenant all day long.

Seattle has not traditionally been a preleased market, but we think we are going to be successful in preleasing based upon deals that we are discussing right now, and the fact that the market is just absolutely breathtaking in terms of what's happening. There is a certain tenant right now that looks like they are taking the 600,000 feet or thereabouts that's in the Denny Regrade space, which -- Denny Regrade location. We have some vacant space -- or some space, rather, that's not going to be renewed in one of our buildings in South Lake Union. It is roughly 120,000 feet. We have multiple different people that are bidding on that space. So the demand profile in that city is really good, and I hope to be able to see us do some substantial preleasing. Would we start at spec? Potentially, but what would we have to do to start spec? We would want to make sure that would be are well leased at The Exchange.

So we are not going to get over our skis. I think we've made that clear to everybody before. And we are very encouraged by what we are seeing across our markets right now with current demand, and so much of it is really big tech. And by big tech, I'm talking about established companies with massive balance sheets with real growth plans.

Okay guys. That's it for me. Thanks.

Vincent Chao, Deutsche Bank.

Good morning/good afternoon everyone. Just going back to the 100 Hooper here, I think I heard, when you were talking about the exchange, about two or 2 million or 3 million square feet of activity around that project. I was just curious if you had the numbers for how much demand is behind 100 Hooper. And then also I think that one, the focus had been on The Exchange and not as much on marketing 100 Hooper. So just curious. Was there anything specific that changed to spur some additional interest at that site?

We bought the site, what, a year ago, and we said we were going to hire a brokerage team and kind of revise the plans a little bit, which we did in both cases, and began to market it. And we've always made clear that we wouldn't start Hooper unless we had either substantial progress at The Exchange or substantial preleasing at 100 Hooper. And it would be wrong for anybody to think that The Exchange or 100 Hooper are somehow fungible is between tenants. There are two different markets. Some tenants would go in either location. Some tenants will only go to Mission Bay, and The Exchange. Some tenants will only go to stay in that market that 100 Hooper is in. So, again, there may be occasion that they are attractive to the same user, but we think of them more as unique submarkets within the city. And what's happened is that we have, as a result of our marketing efforts at 100 Hooper, uncovered a number of folks that want to be there. And so we are negotiating detailed paper with a couple right now. And you asked how much, and let's just say we've got more than enough to fill up the building if they all go together.

Okay, thanks for that. And just curious, so AVB, we heard from them this morning, and they were talking pretty cautiously about San Francisco. Obviously, there are different property types, different parts of the cycle. There is some supply coming on there. But they did specifically mention job growth and some demand softening there, but it seems to be in contrast with the increased activity that you guys are seeing in San Francisco. I was just curious if you had some thoughts on what your outlook for job growth is overall for that market, and if it's just that the slowdown is coming from parts of the market that you are not really catering to for these two projects.

I don't know, Rob, do we have statistics or, Mike, with regard to what the projection is for job growth for the market? I can tell you that don't confuse office and apartments. We want everybody to do well, but a back-off in rent increases at apartments is actually a very good thing for the office community because it makes it more affordable for the people that they are hiring.

And again, I don't know what they're talking about, whether they are talking about current rents that they are more cautious about, etc. We're talking about deals that we are working on for occupancy that are a year and half or so out. Do we (multiple speakers) numbers for job growth? We'll have to get that to you. I don't think we have that in our pile of papers here.

Okay. Yes, I think the caution was more of the job growth side of things, which obviously has an impact on rent. But it does seem like you are seeing some good demand there, so just trying to understand the differences. Okay, thanks.

John Guinee, Stifel.

Okay, great. Actually just a couple of questions off case a bit. Hey, Jeff, I'm looking at Southern California, and while I get that San Francisco Bay, your leases are 33% below market, I get that San Diego 8.5% above market. There aren't many sub-markets in LA that are below 10% vacancy. Yet I think you are thinking that you're 16% below market in your LA portfolio. Any more detail on why you are so far below market in those markets?

I'm not sure. So for LA, obviously mark-to-market, we are at 16% for all of our properties in LA.

But El Segundo and Long Beach are not particularly great markets. Do you just have low in-place rents there, or what's driving that below market number?

I think mainly West LA. West LA, we have huge upside mark-to-market in our West LA portfolio in Santa Monica. That's really driving it more than anything.

Got you. (multiple speakers) John, I'm just looking at all your development portfolio, and the investment basis looks pretty good in most of them. Let me just ask you a couple of questions. $700 a foot on Exchange Place looks like a pretty good number, $640 a foot at 100 Hooper, $580 a foot at 333 Dexter, $600 a foot at Paseo, $700 a foot at Academy. Anything we are missing on those investment basis development basis per square foot? And then a question I guess for David Simon. It looks like the Columbia Square project that you just delivered came in at almost $800 a square foot. Any idea why that's so high?

You remember you're looking at an overall number and you have the residential component baked into that. If you break it out, the office is in the $600 a square foot range, and the resi on a per-unit basis is as, we said, $160 million. And then we had the historical. So when you look at the components, they are all where they should be relative to returns and the market they are in.

Okay. And then any investment basis that we should be concerned with on your development pipeline?

I don't think so. For a long time, we were sort of sweating it down at One Paseo because we didn't have entitlement and so forth, but now we do. They're irrefutable, they are fully entitled, and the yields there won't be as high as -- they won't be in the 8% range, but remember about, what is it, 60% of the project, Tyler or Michelle, is resi?

Correct. 65%.

So we are going to be overall there. We think we've been pretty conservative in our underwriting and in our contingencies in our forecast for potential increase in costs, and we are still with the 60% of it resi and, what is it, 15%, 20% --

25% office and 15% retail.

Yes, we think we are going to be there producing in the sort of low mid 6% yields overall, maybe a little bit better.

Okay. Thank you.

Michael Carroll, RBC Capital Markets.

Thanks. Tyler, you mentioned the possibility of a 1031 exchange later throughout this year. I guess can you guys give us some color on the type of acquisitions the Company is pursuing and the likelihood of closing some type of transaction?

No, the reverse. We had sold an asset at the beginning of the year and then put the money into an account. In the case of doing a 1031, we decided we are not going to do a 1031. So the money now we've pulled out of that account and paid down our lines. So we have no plans to do a 1031 at this point.

Okay. And then can you talk about how long it would take to deliver 100 Hooper Street once that project breaks ground?

It's about 18 months, Mike?

16 to 18.

Great. thank you.

Jed Reagan, Green Street Advisors.

I think Mike touched on this, but there was a media report yesterday that Facebook is looking at a big office lease in San Francisco and specifically Central SOMA. Can you comment about any conversations you may have had with Facebook about your projects there, especially Flower Mart? And then can you just remind us what the latest timing is for the city to make some decisions on the Central SOMA redistricting plan?

I'll let Mike deal with the latter part. The first part, we are not going to talk about any discussions we are having with Facebook or anybody else specifically until -- any particular tenant that we are talking with or may be talking with, until we have a deal. Because we are just not going to do that.

With regard to the Central SOMA, Mike?

Yes, I think they still remain on track. We are looking for a certified EAR later this year, and then sort of administrative approvals thereafter early 2017, plus or minus.

Okay, great. And can you talk a little bit about how the investor demand for your San Francisco JV offering has fared? Were there a number of parties you were talking to there? And then just how is pricing there shaping up versus your initial expectations?

There were a number of people that wanted to do transactions with us on various assets in San Francisco and elsewhere. We went through a process over a course of, I don't know, six to nine months talking with various sovereigns and other major players to determine who we thought would line up with their strategic interests and our strategic interests being most in alignment. And pricing was heavily negotiated, and it will be I think consistent with where other things are trading in the city today.

Okay. Thanks. And on the Sorrento Mesa sale, can you talk about how -- the buyer allocated pricing between the land and the buildings? Am I correct in thinking that those two buildings had a fair amount of vacancy in them?

The two buildings were both basically vacant, but we can't comment on their allocation. I'm not even sure we know what their allocation was.

Okay. That's helpful. And last one for me, how much upselling potential exists at the Mountain View acquisition, and just kind of what's the process and timing for getting at those FARs?

I think, just in general, Mountain View is a market obviously that we would love to be in and expand more. It's tough to get into. I think we found this opportunity, but it's definitely under-densified currently.

I'd say many parts of Mountain View over time have gone through up-zoning and it's very common to see up to a 1.0 FAR plus or minus. This area in particular still needs to go through a process. As John said, we will be working through that over time. But it wouldn't be unreasonable to think about a 1.0 FAR plus or minus in that area.

Okay. Should we think about that as more of a next cycle type of play?

Yes, we are not counting on it the cycle. We've got four years left with the tenants. You recall we bought an asset, I think it's called Chesapeake something in Sunnyvale, right on the freeway a year or two ago which was a similar kind of transaction, roughly the same yield but with a big upside on redevelopment. So, we think these are pretty good ways to get a decent we call them covered land transactions where you get a decent yield going in, slightly accretive, and you have big upside that can generate substantial increases in value over time, allows us to focus on those and have them ready for the next cycle. I can't and I'm not going to call when this cycle ends and the next one begins. It seems to still be going just fine.

Okay, great. Thanks.

Dave Rodgers, Baird.

John, earlier I think Steve asked a question about preleasing uncertain development, but maybe take that a different way. Do you guys look at it from a risk perspective in terms of total capital at risk on a speculative basis that you would be comfortable with? I guess if you threw Exchange in there and then kind of the four new developments plus the resi that's kind of leasing up now. Do you kind of have a max limit in terms of total dollars that you want exposed on a speculative basis at any point? Maybe a different way to think about preleasing?

Yes, we get asked that question from time to time. We don't really put ourselves at the hard and fast, because where I've kind of made some mistakes in my career, speaks to me, is that it can be a modest amount, but if you're doing it at the wrong time, then it can create a lot of pain. We look at it more about not -- I guess we could look at it as a percentage. We really haven't. We've looked at it more what's in the market? What demand is in the market? We are so involved with companies with regards to their long-range planning that we have a pretty good feel for what is out there. We want to see big, visible demand. We don't want to have huge volumes of dollars invested in projects that are vacant. I know everybody is wanting to see progress on The Exchange, and we are dedicated to make sure we show progress this year, but we look at it both industry risk, geographic risk, dollar risk, timing risk. We look at our existing portfolio and we look at what is potentially coming due because we obviously don't want a huge amount of spec space in a market where we have a huge amount of space coming due in the same year or same period. So, we take all of those factors into consideration.

I think what we're going to see is, in the remainder of this year, I think we're going to see some pretty good leasing activity based upon deals that we are working on right now across the portfolio. So, I am hopeful that we are going to see substantial lease up in The Exchange and substantial precommitment at 100 Hooper in order to start it. And at 333 Dexter, we talked about that, and One Paseo, we are not going to see substantial preleasing in the first space because most of that is resi. And then on the leasing of the retail, it's not big-box stuff, so it's probably maybe 40%, maybe 50% that we might do preleasing there. So that's kind of the big view.

Great, that's helpful. David, at Columbia Square, the remaining 20% sounds like will be leased by the end of the year, occupancy close to year-end or will that trail into 2017 or 2018?

It will probably trail into early 2017 and we should be buttoned up by the end of the year with the amount of activity we have and the paper we are trading on the balance of the space. So yes, that's a good assumption.

Great, thanks. Tyler, last one for you. In terms of doing a joint venture sale but doing a minority sale, I assume that's having no impact on the need for a special, that that's coming from the traditional asset sale this year, or is there some impact there?

We are working on structuring it as a tax-deferred transaction. It hasn't been completed yet, but that's the plan.

Okay, great. Thanks guys.

Jamie Feldman, Bank of America.

Thanks, just a quick follow-up for Tyler. Can you update us on your thoughts on CapEx and AFFO or FAD for the year?

Yes. I think we are projecting a 65% payout ratio on FAD for 2016. You know, it will bounce around a little bit here and there with CapEx. We have an overall CapEx CI leasing commission building and maintenance budget of around $80 million. We will probably come in underneath that. But it's trending similarly to prior years.

Okay, and I think similar to your last -- I think that's what you said on the last call too.

Yes.

Great. Thank you.

There are no questions at this time. I will now hand the call back to Tyler Rose for closing remarks.

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

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a great day.