Kilroy Realty Corp (KRC) 2016 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q4 2016 Kilroy Realty Corp. earnings conference call. My name is Lauren and I will be your operator for today. (Operator Instructions). I would now like to turn the conference over to Tyler Rose, Executive Vice President and Chief Financial Officer. Please proceed.

Good morning, everyone. Thank you for joining us. On the call with me today are John Kilroy, Jeff Hawken, 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 packet for a statement regarding the forward-looking information in this call and in the supplementals. 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 fourth quarter and the year. Jeff will discuss conditions in our key markets. I'll finish up with financial highlights and a review of our initial earnings guidance for 2017, which was published yesterday in our earnings release. Then we'll be happy to take your questions. John?

Thank you, Tyler. Hello, everyone, and thank you for joining us today.

2016 was another exceptional year at KRC. We delivered strong results across all areas of our business and continued to create value in our operating and development platforms that will drive future earnings and dividend growth. We are encouraged by the continued strengthening of our markets, as measured by low vacancy rates, increasing demand, and rising rental rates.

I'll start my comments today with a quick review of our 2016 accomplishments. We delivered strong leasing results in all of our stabilized portfolio, driving occupancy to 96% and boosting our same-store cash net operating income by 14%.

We delivered 1.1 million square feet of new office space that is 93% committed, including space to salesforce at 350 Mission Street, space to Dropbox at 333 Brannan Street, both in San Francisco; and space to Viacom and Fender guitars at our Columbia Square project in Hollywood. We delivered our first residential project, midyear, that is now over 60% leased. We signed a lease with Adobe for 66% of the office portion of 100 Hooper in San Francisco. And just yesterday, the lease was expanded to include all or 100% of the office space. We commenced construction of the project in the fourth quarter.

We secured entitlements on 2.3 million square feet of new office in mixed-use development, including One Paseo where we just broke ground, and we expanded our Flower Mart development site with the acquisition of additional parcel. The site now aggregates seven acres.

In a highly competitive acquisition market, we remain selective, but engaged. We acquired three properties with unique value-add opportunities and one that expands our reach into life sciences.

Throughout the year, we maintained our commitment to financial strength and disciplined capital management, generating $795 million in proceeds from nonstrategic asset dispositions and a new venture and raising $775 million in new debt and equity, including our January offering. We ended 2016 with a strong balance sheet, a significantly enlarged capacity to finance our enterprise as we grow, and the capital resources in place to fund the next leg of our development program.

Finally, we continue to focus on enterprise development. We expanded our relationships and deepened our access to multiple capital sources. We strengthened our overall management team, bringing on experienced talent to lead our efforts in life sciences and our expanding operations in the Pacific Northwest. We enhanced our tenant relationships up and down the coast and we extended our industry leadership in sustainable development and property management practices.

Now let me review the fourth quarter. It was a busy period for us, with two value-add acquisitions, strong leasing performance, and continued progress in our development program. I'll start with our two acquisitions. The first transaction encompasses two buildings located in Stanford Research Park, one of the premier technology centers in the country. Current tenants in the area include some of the biggest names in the S&P 500, including Ford, Lockheed Martin, and DuPont and some of the Valley's most innovative enterprises, including Tesla, Nest, and Google.

We acquired the two buildings for a total purchase price of $130 million. They are situated on 8.5 acres and, like all properties at the park, are subject to a ground lease with Stanford University, which offered us a 51-year term, the maximum duration. The first property at 1701 Page Mill Road is essentially a brand best-in-class offices life sciences building totaling 129,000 square feet. It's fully leased to Theranos. The second property at 3150 Porter Drive is a 37,000-square-foot office building fully leased to the law firm Perkins Coie.

We were attracted to this acquisition for several reasons. It is a well-priced entry point for us into the Palo Alto market and an opportunity to expand our life sciences portfolio. Both buildings come with strong current cash flow and both represent excellent long-term value creation potential, given current in-place rents that are approximately 20% to 25% below market.

In the nearer term, the acquisition represents a low 5% cap rate. We believe we can grow this to north of 7% as we convert the below-market rents to market and potentially adjust the tenant mix.

Our second acquisition is known as The Sunset, a 179,000-square-foot mixed-use project with 420 feet of frontage on the iconic Sunset Strip. We paid approximately $209 million for the property, which includes a 10-story, 72,000-square-foot office tower; a three-building, 107,000-square-foot retail plaza; and a four-level subterranean parking structure with five spaces per 1,000 square feet of office, which is twice that of any neighboring structure. The property also has three fully leased billboards atop the retail buildings.

Excluding the parking and billboards, we paid approximately $800 per square foot for the office and retail components of the property, which are currently 87% occupied. Average in-place rents are estimated to be 15% to 20% below market.

We believe we can unlock the property's value in a number of ways, through fully leasing the office component at market rents, repositioning and enhancing the retail component, and improving revenue generation from both the parking structure and the billboards. We expect these actions will boost our initial low 4% cap rate on the acquisition to the mid-7% range.

Leasing was another big story for us in the fourth quarter. We signed leases totaling 663,000 square feet, materially reducing our 2017 expirations and prompting us to move ahead with new projects in our development pipeline. In our stabilized portfolio, we signed new or renewing leases on 456,000 square feet at rents that were 12% higher on a cash basis and 33% higher on a GAAP basis. Among the biggest deals was a 12-year lease with Amazon for 273,000 square feet at our 320,000-square-foot, two-building Westlake Terry office project in the South Lake Union neighborhood of greater Seattle. Amazon will occupy -- its occupancy of an initial 150,000 square feet following the expiration of an existing tenant lease that is scheduled to expire in September.

We also had 500,000 square feet of LOIs outstanding at year-end in our stabilized portfolio, including 160,000 square feet either executed this quarter or close to being complete. GAAP and cash rent levels on the LOIs are 41% and 20% higher than prior leases, respectively.

We also made progress on our development programs. As I mentioned, in November we signed a 13-year lease with Adobe for 207,000 square feet of office space at 100 Hooper, our 400,000-square-foot office and PDR project in the SoMa district. And just yesterday, they signed on for another 107,000 square feet of office space in the project. We are now 100% leased on the office component, which will generate 88% of the overall project NOI. As far as the PDR space goes, we expect to make leasing progress on this component as we near completion of the project. We commenced construction on 100 Hooper in November, with an expected delivery date in the third quarter of 2018.

At The Exchange on 16th, our approximate 700,000-square-foot office life science project in the city's Mission Bay neighborhood, negotiations are well underway and now focus on a long-term lease for the entirety of the project, coupled with a prospective tenant making a significant equity investment in the project and thereby taking a minority ownership position.

As I mentioned earlier, we also commenced construction on our One Paseo project after eight years of entitlement purgatory. The community of Delmar, including former antagonists to the project and the mayor, helped us break ground last month. One Paseo will transform the neighborhood into a world-class live/work/play destination, bringing abundant retail to a market scarce of modern dynamic options, as well as premier residential units where vacancy has been at frictional rates over the past years and where no new competing supply is currently planned.

You will recall that we received final entitlements for this 1.1 million-square-foot mixed-use project last summer. We've now begun the first phase of construction, which includes site work and overall project infrastructure, approximately 237 residential units, and 96,000 square feet of retail space. We estimate incremental spending for Phase 1 will be somewhere in the $150 million to $200 million neighborhood, with deliveries beginning in mid-2018.

To summarize our active and potential new development moving into 2017, we now have three projects under construction, The Exchange, 100 Hooper, and the first phase of One Paseo, totaling 1.4 million square feet and representing a total estimated investment of approximately $980 million.

We also have three projects in our near-term development pipeline that are fully entitled and ready to start, subject to market conditions. These include 333 Dexter in South Lake Union, the Academy in Hollywood, and Phases 2 and 3 of One Paseo. These three projects total just under 1.9 million square feet and represent a total estimated investment of approximately $1.2 billion.

On the life science front, among a number of initiatives we continue to work on entitlements for a five-story, 150,000-square-foot life science project on the side of our existing 9455 Towne Centre Drive office building in San Diego. Demand in the area for this type of property is strong and growing.

Lastly, I'd like to reiterate how powerful our development program is and it continues to provide us with substantial NOI growth. Since 2013, we have delivered nine office projects and one luxury residential tower. They now generate more than $120 million of NOI on an annualized basis. In addition, we expect to generate another $65 million to $75 million of NOI on an annualized basis over the next two years from the projects we have under construction. In the aggregate, this NOI represents a 60% increase over our total Companywide NOI for 2013 and doesn't include any NOI from our near-term or future pipelines.

Let me finish by commenting on our West Coast market trends. We see a fundamental evolution in what constitutes a high-tech company. Healthcare, transportation, auto, defense, entertainment, lodging, retail, and even travel services are now being profoundly impacted by technology. This change is producing a meaningful result in all of our markets. Fortune 500 companies and formerly staid industries are acquiring technology startups in order to stay relevant. GM's $1 billion acquisition of Cruise Automation is just one example.

Mature tech companies are using their massive cash flows to acquire new companies with potentially game-changing ideas to move into faster growing spaces and to gain access to increasingly scarce talent. A whole range of new companies are being drawn to centers of high-tech innovation, including our West Coast markets, and the increase in M&A activity has enhanced the credit profile of our portfolio, with transactions like Microsoft buying LinkedIn, AT&T buying DirecTV, Adobe absorbing Livefyre, and, most recently, Cisco acquiring AppDynamics. We believe this trend will continue and even accelerate in the years ahead.

And this evolution will continue to drive demand for workspace in dynamic urban centers that deliver the live/work/play convenience and amenities that attract young creative talent. This is the 21st century version of locating your production near the raw materials and transportation resources you need to succeed.

Companies continue to address rising cost issues by seeking out real estate partners that are flexible, forward looking, and innovative in their thinking and who are accountable in the timely delivery and quality of their products. We see a rising bar for property efficiency, for sustainable practices, and for work environments that promote both human creativity and enterprise productivity.

From a real estate fundamentals perspective, as Jeff will outline later, our markets continue to improve, and while we may not see the same level of growth that we saw a few years ago, we don't see any signs of a correction.

Finally, in a year that was filled with many surprises, we remain true to our core business principles; financial strength and discipline; a fully integrated operating platform capable of developing, acquiring, repositioning, and managing our own assets in a high-quality, well-located property portfolio that we continually update to maintain its relevance and value. I have no doubt that our commitment to these principles drove our success in 2016. They remain the bedrock for our plans moving into 2017 and our ability to build value for our shareholders over the long term.

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

Thanks, John. Hello, everyone.

Let me start in San Francisco, where the office market posted a record 26th consecutive quarter of positive absorption, fourth-quarter leasing volume reached 1.6 million square feet, and net absorption for the year was 860,000 square feet.

Leasing demand both for large blocks and otherwise continues to target quality built-out space on a direct and subleased basis. This can be seen with the high demand for low to midrise development projects that are well leased and command a rent premium over market rates. Rental rates increased slightly over the prior quarter, bringing annual growth to 7.1% from year-end 2015.

Class A direct vacancy was 3.2% in San Francisco's SoMa district, 5.5% in the South financial district, and 3.9% in Mission Bay. In Silicon Valley, Class A direct vacancy was 6.8%. We are currently 98.4% leased in the Bay Area and our in-place rents for the region are approximately 32% below market.

The Seattle/Bellevue market has continued to experience tremendous demand from large tech companies, including what is now known as GAFA, Google, Amazon, Facebook, and Apple, that are adding employees and needing more space in the region. 2016 was the fourth straight year the market experienced north of 2 million square feet of absorption.

Popular submarkets, like Bellevue and South Lake Union, are attracting the greatest attention. Class A direct vacancy in Bellevue stands at 11.5%; in South Lake Union, it is 5.5%. Our Seattle portfolio is currently 97.6% leased and our in-place rents are approximately 7% below market.

Growth in the San Diego market has been driven primarily by healthcare and life sciences, and both industries continue to expand. The market had positive net absorption in the quarter of 920,000 square feet, the largest single quarter on record, largely driven by City of San Diego, Illumina, and Renovate America. The year-to-date total was 1.8 million square feet, which represents almost two times the level of the past five-year average.

In Del Mar, Class A direct vacancy was 12.3%, and in Sorrento Mesa, a two-story corporate office, vacancy was 5.8%. Our San Diego portfolio is currently 94.4% leased and our San Diego in-place rents are approximately 9% above market.

Los Angeles is in the midst of an urban renaissance. The city is encouraging more residential options, creating and improving amenities, and has plans to further expand public transportation options. The effort is attracting large numbers of new urban residents, many of them young, creative talent that employers, entertainment, media, fashion, and technology ventures seek.

The Westside and Hollywood remain two of the most popular submarkets. Class A direct vacancy in West LA was 7.8%. West Hollywood was approximately 3.8%, and in Hollywood, it was approximately 8.6%. Our Los Angeles portfolio is currently 96.8% leased and our in-place rents there are approximately 17% below market. Across our portfolio today, we estimate average in-place rents remain 17% below market.

Looking across our 2017 expirations, we have substantially reduced the 1.1 million square feet of space rolling this year. Adjusted for approximately 315,000 square feet of signed leases, including Amazon's lease, and another 166,000 square feet of LOIs, we have just under 600,000 square feet of expirations to address for the remainder of the year, with no single expiration larger than 50,000 square feet. In-place rents on our 2017 expirations are approximately 21% below market. Amazon is scheduled to take occupancy of the Westlake Terry space at the end of the first quarter 2018.

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

Thanks, Jeff.

FFO per share was $0.87 in the fourth quarter, which includes $0.01 of acquisition-related expenses, and was $3.46 for the year, representing a 7% year-over-year growth rate when adjusted for one-time items. Same-store NOI continued to show substantial growth in the fourth quarter, driven by higher rental rates and higher average occupancy. Cash same-store NOI was up 9.1%, and for the year it grew 14.3%. GAAP NOI rose 6.7% in the quarter and 4.6% for the year.

Turning to the balance sheet, we completed a number of transactions during the quarter. In November, we completed the second tranche of our Norges venture, which generated $[252] million. Also in November, we completed a 10-year, 3.57%, $170 million secured mortgage. After paying off a $65 million maturing mortgage, the loan added $105 million to our cash position.

Across the fourth quarter, we raised $32 million of equity through our ATM program. Then in early January, we completed a public offering of just over 4.4 million shares of our common stock, generating net proceeds of approximately $309 million.

And last month, we completed the sale of a small office property in San Diego for net proceeds of $12 million.

These transactions, coupled with the $250 million of private placement debt we will draw later this month and the dispositions we completed last year, have provided sufficient capital to complete our two December acquisitions; fund development spending through 2017 not only for the three projects under construction, but also the potential two new starts; and meet all of our debt refinance and preferred stock redemption needs in 2017, while ensuring a strong and stable financial position and the dry powder to act on unplanned opportunities when they arise. Including the drawdown of the private-placement notes in two weeks, we will have $585 million of cash on hand.

We expect to have full capacity of our bank line at year-end 2017 and we retain significant additional debt capacity. Our debt to market cap is in the mid-20s. Our debt to EBITDA is under six times. We have a large, unencumbered portfolio and we have no floating-rate debt, except for a modest term loan.

Now let's discuss initial guidance for 2017. 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 shift in the economy, our markets, end demand, construction costs, and new office supply going forward could have a meaningful impact on results in ways not currently reflected in our analysis. Projected revenue recognition dates are subject to several factors that we can't control, including the timing of tenant occupancy.

With those caveats, our initial assumptions for 2017 are as follows. As always, we don't forecast any potential acquisitions or acquisition-related expenses.

We anticipate 2017 development spending on our projects under construction to be approximately $300 million to $350 million. We project same-store cash NOI growth between 2.5% to 3.5%, given we are fully leased. First-quarter same-store results are expected to be higher, with growth moderating throughout the year. We expect straight-line rent of approximately $36 million for the year. Approximately 50% of this is attributable to development projects. We expect operating margins to be about 70.5%.

We expect year-end office occupancy to be in the 93.5% to 94% range. The decline from year-end 2016 will be driven largely by the group health space in Seattle and moveouts in Santa Monica and Orange County properties. We also expect approximately 300,000 square feet of moveouts in the first quarter, with almost a quarter of this space already committed.

For our residential tower, we expect occupancy by year-end to be in the low 80% range.

Our recurring CapEx budget is approximately $75 million, which would result in an [F 80] payout ratio of approximately 70%, assuming everything else stays the same. The Board will continue to evaluate the dividend regularly, but we anticipate a larger dividend increase in 2017, potentially in the 20% range, as we approach meeting our minimum distribution requirements.

In terms of capital recycling, our current range for dispositions is between $100 million to $300 million, with a $200 million midpoint.

Lastly, our current plan is to redeem $200 million of preferreds that are callable at the end of March and in mid-August. While this will be accretive from an economic perspective, it will generate a non-cash charge related to the original issuance costs. This non-cash charge is not included in our guidance.

Taking all these expectations into account and considering all of our pre-funding activities, we are providing initial earnings guidance for 2017 of $3.40 to $3.60 per share, with a midpoint of $3.50 per share. As I said, this range excludes the non-cash charge related to the preferred redemption.

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

(Operator Instructions). Manny Korchman.

It's Michael Bilerman. Good morning out there. John, I'm curious. You have now, I guess, it's about 130 predominantly tech companies have signed the immigration ban letter that went to Trump, a number of which -- many of which, actually, are your tenants, four, actually, of your top tenants. I'm just curious your views on the impact to the San Francisco and West Coast markets that this could have and how you either individually or as a Company plan to get involved.

I don't know that we plan to get involved, Michael. I think we like to think that we have a voice, but compared to Apple and Microsoft and Facebook and Google, etc., etc., I think those combined voices are probably a little bit clearer and stronger than ours.

Obviously, there's a lot of things coming out of Washington coming across some of the products that these people develop, Twitter and so forth. Who knows what the implications will be? I think you just have to look at the calmer heads here. Obviously, the President has said that his top priority is to stimulate growth and get people working and expand the economic pie. No industry provides the growth that tech does and no industry helps the US maintain its competitive edge greater than technology does.

I can't say what the President's view is going to be in the future. I bet on the -- it's not just the tech industry. This affects everything. Automobiles, every industry relies upon technology. So, I can't -- I can only speculate since I don't have, obviously, the crystal ball that permits me to give an accurate answer to that question. It reinforces my view that I have long held that I hate politicians.

But I guess the premise is that if all these companies believe that it impacts their hiring or their ability to recruit talent into the West Coast markets, doesn't that have some knockdown effect on the marketplace that you have to be concerned about, and does that get you thinking about diversification at all? Because it is, it will have a dramatic impact, given the number of employees that these companies hire from foreign nations.

Well, it's not just -- if it were to happen, it's not just going to affect the West Coast. It's going to affect New York and Chicago and Austin and Denver and Detroit. It's going to affect every bloody market in the country because the backbone of all of us is technology, and so, yes, I hear you.

The fact is we have tremendous credit. We have long-term leases. And with the four or five unicorns we have, we have huge letters of credit. So, I'm not sanguine about it. It's one of the reasons we have the balance sheet we have is because you've got to navigate through whatever the potential macro implications are of bad policy or wars or whatever. You know, we are not isolated, nor is any company, nor is any REIT.

In terms of diversification so far, I don't really want to get into it on this call. Obviously, we are always looking at what else we should do. But it's a real issue. The fact is we don't churn out enough brilliant people, scientists, mathematicians, and so forth, in the United States, and if you take a look at whether it's financial companies or hedge funds or the brainpower, and I guess a lot of American industry, not only technology, a lot of those folks, I don't know what percentage, but a lot of those folks are not US nationals. They are here on visas. So, it's a huge issue for the entire country.

And then, just second question is just on The Exchange. I think you mentioned early in the call of some single tenant that would also take an interest in the project. I was just wondering how we should think about, a, your total capital commitment, that [485] at your basis relative to what sort of level of interest this tenant would take into the project as we start thinking about, a, the return on capital, but also the amount of capital you have to outlay for this specific project if someone is coming in and taking some of it away from you.

Obviously, if we end up with them being a venture partner as well, it's going to reduce our capital outlay. Depending upon the amount of interest they have, their basis is going to be a lot different than our basis. I don't really want to get into too many specifics because we are in the midst of a negotiation.

And the venture part of it can about as a result of they're looking at the long-term strategic nature of this asset and the long-term lease commitment and then, ongoing, what are going to happen in various lease accounting changes and so forth. And so, they have decided that they'd really like to have maybe 30% to 40% equity investment in the property.

Thank you.

Craig Mailman.

John, just maybe a follow-up on The Exchange. Is this tenant that you are negotiating with now, was this an LOI that was part of the batch that you guys kind of talked about back in October or is this one new?

No. It's the one we've been talking to. This has been a long negotiation related to the same tenant.

Okay. That's helpful. Then I'm just curious. In guidance, Tyler, are you guys assuming anything related to Theranos in terms of vacating the property? Or are they just assumed to be in all of 2017?

Yes, the underwriting is they will be in for 2017.

Okay, and then just lastly, do you have the G&A and interest assumptions for guidance?

Cap interest is $47 million or so.

Yes.

Cap interest is spread out for the year, about $47 million. G&A, we expect to be on top of or maybe slightly higher than the overall 2016 number. The fourth quarter was a little bit high for various one-time reasons, so the run rate is not the fourth-quarter rate. It will drop back down, but the overall amount for 2017 will be roughly the same or slightly higher than 2016.

Nick Yulico.

Just going back again to The Exchange. John, I thought you said it was an existing tenant that you are talking to. Did I hear you correctly?

No. If I said that, I misspoke. I don't think I said that, but if I did, I misspoke.

No, it's the same tenant we've been working with for some period now. We had a detailed negotiation with regard to the terms of the lease and all -- going through all the work letters and all that sort of stuff, and as I mentioned a few moments ago, their desire now is to have a long-term lease because of the strategic nature of it, but to end up with an equity position because that helps them and is the way they account for their lease accounting costs and so forth.

Okay, I just wanted to be clear this wasn't -- this is not a situation where you are moving an existing tenant in your portfolio.

No, that's not the case. And I should just mention on everybody's behalf with regard to The Exchange. You know, just the nature of the market here in San Francisco for this kind of product could not be stronger.

As you've seen, we've started. We announced in November the deal with Adobe. We started construction in December. We announced today that the balance of that office space is gone. There's nothing in this kind of product that is available in both life science and office. Demand for this kind of product is so strong right now that we are very, very comfortable where we are with The Exchange. We hope to make the deal that we are working on, and if we don't, then we have backups that we are very comfortable with.

Okay, and so is the thinking that you want to first get this finalized before you start thinking about Dexter and Seattle and the Academy Project in Hollywood?

I had a feeling that question might come up. As I said about Dexter and the Academy and whatnot, our focus was The Exchange and 100 Hooper, and that we'd have to do some significant leasing in those projects, or significant enough to get comfortable to start spec, either the Academy or Dexter. I don't see starting both of them spec. It's just there's no need to do all that at once.

The thing that's really happened that's just really been phenomenal since we all last talked in -- about Seattle, there was 1.5 million square feet under construction spec in three different projects in Bellevue, and we thought that was going to have an impact on us as we re-leased property in the Skyline, where we've got a couple hundred thousand feet coming up next year.

Rob Paratte, with regard to that 1.5 million square feet in Bellevue right now, how much of that is leased and how much is kind of under LOI?

We think there's 500,000 feet remaining and it's basically committed as of some of the conversations we've heard about in the last couple of weeks.

So essentially, Bellevue is cleaned up. South Lake Union has nothing, nothing available of any consequence, plus Google took 700,000 or 800,000 feet on a build to suit. Facebook took 400,000 square feet on a build to suit. You could not be better positioned than Kilroy is right now, and we have big, big interests and lots of tours going on.

So, more to come on that. It's really been amazing to see the acceleration of leasing and the movement of rental and the ongoing demand in that market. So, I'm feeling pretty good. The politicians always scare the hell out of me, but I'm feeling pretty good when I look at our markets.

All right. That's all I had. Thanks, John.

Jamie Sullivan.

Tyler, when you walked through the guidance, you mentioned several moveouts. Can you just walk us through the big pieces in the guidance for 2017 and when you think -- when the moveouts happen and when you think they get backfilled, or the leasing prospects, if they are not backfilled?

Yes, so the big one obviously is in Seattle, which I mentioned, which the moveout is in September and they won't -- we don't expect the new tenant to move in, Amazon, until next year. So that won't come back in in 2017.

The other two I mentioned are in Santa Monica and Orange County, and I think the -- Jeff, you may have to help me on this in terms of the expectation of when those will be backfilled. I mean, I don't think it's -- it's closer to the end of the year on both of those square footages.

That's correct. It's spread through the year, but back loaded to the end of the year.

So it's just the three?

Well, those are the three bigger pieces, yes.

Okay. And then, can you guys just provide generally more color on Silicon Valley itself in terms of the leasing pipeline, and then maybe talk through some of the competitive supply that's coming up in the market and how you're thinking about the competition and leasing prospects?

Jamie, it's Mike. Good morning. So I think the Valley remains extremely strong, as you heard in the comments prior to the question-and-answer period here. 6% vacancy rates, historic lows. Demand for tenants remains very strong in the marketplace.

As you mentioned, there is some supply coming on in the market there. From our perspective, all of our product in the Valley is long-term leased. We don't have, really, any material role coming up in Silicon Valley proper, because we have a lot of long-term leases in place in that marketplace.

So in general, we feel very good about our product and we have been, as you know, playing in that market for a while now in projects like Box in Redwood City where we did deals in the mid-fours and now rents are in the $7 range, the LinkedIn deal, so on and so forth.

So we got in that market early. I think we've done well. We've executed long-term leases. From our perspective, our portfolio is well protected from any sort of future movements in the market, but in general, that market remains very strong. The big three are growing weekly, monthly in that marketplace. So we think that there will be some haves and have-nots and some flight to quality in some of their product that is coming out, but in general I think all signs down there remain pretty strong.

Okay. And then, have you seen any leasing delays based on the H1 visa discussions? Are you seeing (multiple speakers) decisions on hold?

No.

Okay, and then finally, just back to the three expirations you mentioned. Can you talk about a mark-to-market on those leases?

Do we want to get into that? On the Amazon thing, I don't think we can talk about the lease rate. David can maybe comment on the Santa Monica.

Hey, Jamie. David here. As you know, MTV, part of Viacom, they were in our 26th Street deal, about plus or minus 50,000 square feet. They consolidated and moved to Columbia Square. There's probably about an 80% increase, plus or minus, of rental rate that is available for us in that project as we work through repositioning it and bringing it back out to the market.

And Jeff, I don't know if you can comment on Orange County.

Yes, the Orange County is probably in the 25%-plus increase in rents.

Okay. All right, great. Thanks, everyone.

Michael Carroll.

Can you guys highlight how you're thinking about the acquisition activity going forward? Did the Company already complete the deals that they kind of highlighted or you guys were eyeing last quarter, or are you still seeing opportunities out there?

This is John. We kind of zero-base budget for acquisitions because we're going to be opportunistic, as you've seen. If you look at that graph, where we bought plus or minus $800 billion in 2010 and 2011 and 2012, and then -- I don't have it before me, and it dipped down to, I think, zero the next year and then it was a couple hundred million. And this year, it's been roughly, Tyler, $300 million or so, $350 million in three different buys, the two I mentioned in the call, the covered land play in Sunnyvale earlier this year -- not Sunnyvale, where was it? Mountain View, sorry.

You know, if we are going to be opportunistic, I don't see it happening in scale. It's just too -- the market is -- you just can't find things. There's so much money looking to buy stuff and it's compressing the cap rates. I've been surprised to see how the cap rates have compressed in some of what I would call tertiary markets or for product that you really wouldn't want to own. It's not long term. But there's so much money looking for stuff that I just don't think you are going to see Kilroy being a big buyer.

Having said that, if we find something that we think we really can turn into a -- improve it through some value-add component like we see in the deals that we just did, then we'll act on it. With the balance sheet we have, we are prepared to go with development when it makes sense. We're prepared to acquire when it makes sense. As we've said, we're going to dispose of things as it makes sense. We're going to stay in a very kind of conservative range.

Okay, great. And then, can you talk about, I guess, your life science portfolio? I know you kind of highlight that on your prepared remarks. Do you want to grow this exposure? And if so, I guess, what's the strategy of growing that?

I'm not going to get into the strategy because you know and I know there's other people in this industry and they would love to know what we are thinking, so I'm not going to get into that.

Let's just say that we are in three of the four biggest markets, Boston being the biggest, the Bay Area being the second, San Diego being the third, Seattle being the fourth, and if you look at the three that we're in, there's a lot of demand for Class A product. The vacancy rate, like here in San Francisco for South San Francisco, is 3%. Mission Bay, it's essentially zero. There's been some big deals done, Merck and AstraZeneca and Boston Scientific here in the Bay Area.

If you look at San Diego, it's been the area that's been more robust, life science and so forth, and Seattle, again, very tight.

So it's -- we are very good developers. We are very good at executing. With hiring Tracey, and she would be on this call except for she's got the beriberi disease that everybody seems to be getting, and by that I mean sore throat, you can't talk sick, and I don't want her in the same room as the rest of us. She could go on and on about the strength of the market. And so, we don't see acquiring a lot of this stuff because it's also pricing at a pretty healthy thing.

Theranos, of course, was not that big, but there was a product that is in probably the best building in the research park, kind of plug and play for anybody else. If they stay, then great; if they move, that's probably even better. But I'm not going to wish anything on anybody. We like it, the deal that we are doing, and hope to complete, and The Exchange is life science, so that's going to be a big contributor. I think our life science, healthcare in the Company as a component of NOI today, Tyler, is kind of 15%-ish?

Yes, that's right.

With The Exchange and a little building, 150,000 footer, down in San Diego, assuming we don't sell anything, don't buy anything, and just kind of develop the stuff we are developing, I think it goes to high teens or something, maybe 20%. That kind of feels good.

Okay, great. Thank you.

John Guinee.

John, with the exception of 333 Dexter, which looks like you are delivering at about -- or your total budget is about $550 a foot, it looks like everything else is about $700 a foot. Can you talk a little bit about Flower Mart? I think you mentioned an astounding 7 acres. I might have misheard that, but what's the magnitude in the total cost of Flower Mart, based on your current projections?

Okay, the Flower Mart is going to be somewhere in the neighborhood of 2.2 million to 2.3 million square feet, made up of a 150,000-square-foot market hall, 125,000, 130,000 square feet of Flower Mart, and roughly 2 million square feet of office space.

First phase of the project -- you know, don't hold me to this exactly because it's going to move around a little bit, but it's going to be -- the whole project is the better part of 2 billion, call it 1.750 billion or something. The office, if you look at the FAR cost we have on that project, again, this is order of magnitude, it's about low $70 in FAR foot cost. But when we bought the last parcel we bought, we made it significantly less expensive to do all the underground work associated with the Flower Mart and the parking, so that if you put that savings, if you will, against the FAR, it takes us down to roughly a mid-$50 FAR cost in a market that's trading a heckuva lot more than that.

The yields we projected for the project, and again, starting, Mike, in like 2020 or something, whatever it was, and completing the first phase in 2022 or thereabouts, is north of -- well north of 8%, and that's based upon rents that we've blown past since we forecasted. So we think we've created many, many, many, many hundreds of millions of dollars of net worth just acquiring the land.

And you are right. It's roughly 7 acres. It's all contiguous. It's between Fifth Street and Sixth Street, fronting on Brannan, which is the brick and timber street, one block from the Fourth and Brannan Central Subway terminal, which hooks up Market Street, which is on to BART and Caltrain, which is down South, and then it goes beyond Market Street out into Chinatown.

So it is the next -- it's the next enlargement of SoMa. It's going to be the place where all the growth occurs going out, with the exception of some of the high-rises here in the Transbay area. And the product that we are developing is -- we have the super floors like we have in The Exchange where you have up to 15 foot clear. We have four acres of rooftop deck. We have everything and anything that all the tech companies want. We are working with some of our big tech clients in getting consultation from them, as well as the auto people on driverless cars and how we accommodate that, how we accommodate offstreet shuttle parking, all the kind of areas and bells and whistles that they need.

I think we're going to have an extraordinary winter in that project, and with our basis, I like to think the cycle continues and we can develop it in this cycle, but if we have to wait, our basis is so favorable that we are in great shape.

Mike, just one last question. How does the magnitude of Flower Mart compare to Embarcadero Center?

Acreage or square footage? I mean, it's -- it will be the second largest land assemblage in the city, next to Embarcadero Center. Obviously, there's a lot more high-rise there, so they've got a lot of square footage, but scale-wise it's right up there with the top couple in the city, for sure.

Thank you.

[Rob Sloan].

I was just wondering if you could comment on your thoughts or internal policies around starting construction on the three near-term projects. Is it going to kind of be the same path you took where you wait to have at least one signed lease or is it kind of based on a percentage of leasing?

Yes, it's -- I've tried to answer this, Rob, a lot of times, so I'm probably going to repeat myself. We're not going to get over our skis. I could see starting 333 Dexter now that we've done this Adobe deal and what's going on with The Exchange. If we do the big deal at The Exchange we've been talking about, I could see maybe doing 333 Dexter and the Academy, but I don't know that we need to do both.

We've got very good demand. Rob Paratte has been working with, and David's been working with, some big entertainment companies with regard to the Academy.

The thing that is interesting is that in Seattle, it is historically a non-preleased town. The 4 million square feet or thereabouts that was under construction a couple years ago at South Lake Union was all started spec and it's all leased, either upon completion or near completion or well before completion. So you couldn't ask for better timing. We're the only one that can start in the next year of any materiality in a market that is just absolutely in need of space.

The Exchange, or, rather, the Academy, we think we've hit the ball out of the park in Columbia Square with what we've done there. It's kind of a redo of the same, a little bit smaller. Instead of $500 million, it's $400 million or thereabouts. But we're not going to get -- I am 68 years old. I hate debt. I hate -- I'm a risk-averse kind of guy.

Having said that, having the balance sheet we have allows us to take some development risk and we should be taking that when we look at the yields we're getting. On the $1.6 billion of development that we've recently completed and so forth, it's -- we are getting a 7.5% return and 10% of that is resi. On the $980 million, which is The Exchange, 100 Hooper and Phase 1 of One Paseo, with 25% of it being resi, we are in the early 7% going-in ROC.

If you are off a little bit, it's still a hell of a lot better than buying stuff, although there's a strategy for both. But we're not going to get over our skis.

Great. Thanks, John.

Dave Rodgers.

Just a couple of follow-ups for me. Good morning out there. I guess first, David, in Hollywood, can you talk a little bit about the remaining space that you have at Columbia Square? I know it's not a lot. But separately residential, kind of what's the appetite and activity that, and then on the office side, what's that traction telling you about kind of what the Academy should look like going forward?

Sure. Well, first, on Columbia, the -- we had Viacom is open and operating. They are in there. Legend 3D is in there. We are in the tenant improvement stage for a global brand, which has about 40,000 feet, so plus or minus 10% left, and we're space planning a couple of tenants. We have some more activity happening this week and last week. We feel pretty good about the ability to lease the last two floors in El Centro. We have signage available for them, too. So, pretty confident that shortly we should have that committed.

The overall market for the office, LA and Hollywood, and I've always said this is a very fragmented -- it's solid. You have fits and starts of activity. Activity comes. It's either consolidations that Hollywood attracts, which comes from Burbank and the Westside, which was evident with Viacom. The potential for doing something preleased that the Academy, as John mentioned, there are some big users, entertainment users, looking to consolidate similar to what Viacom did and ones that are looking to grow from within. So we continue to talk to them.

Any tenant that is under 100,000 feet doesn't plan three years in advance. Any tenant over 100,000, 125,000 feet, maybe 150,000 feet starts thinking about it. So most of the tenants in that market are typically smaller than 150,000 feet. So pre-leasing doesn't happen as much as it does in northern California.

Viacom was a perfect example. They came after we were about 10 months into the construction.

So we think there is going to be good -- there continues to be good traction, so to speak, with the mid-sized tenants, 20,000-, 30,000-, 50,000-footer entertainment, media companies, technology companies, and things like that. So, all is solid in that market.

With respect to the residential, things are going well. We are over 60% leased. We have the short term; we have the long term. Both are at about 60%, 62%. The rates are where we want them to be, and again, they are the higher rates in the market of quality of product and quality of credit and tenant that is moving into there is far superior than what is in a lot of the surrounding products, so we feel pretty good about the profile and the demographics of the people coming to the building. And by the end of the year, as we projected, we should be at 80%, and we feel pretty confident about that going forward and continuing to grow that tenant base and that demographic, bringing those people that wouldn't normally live in Hollywood live in Hollywood. With Netflix, Viacom, and all these corporate tenants coming, the demand for upper-scale housing and apartments continues to grow.

Great, thanks for that. Tyler, maybe just one question on guidance for FFO. The Exchange, do you have anything in your guidance for leasing or monetization for 2017?

No. The project won't be ready for occupancy until next year, so there's no [potential] for that.

Got it, okay, thanks. And last, maybe just to John. You talked about the health of San Francisco, and obviously you've proved that out with the developments and the leasing that you've done. When you sit back and look at office employment growth trends, and clearly San Francisco slipped from the top, now nearer the bottom, you don't seem to be worried about that. And, obviously, you don't have a lot of risk in that market, but is that something where you are physically kind of in the market seeing a shift? And maybe the same kind of reverse up to Seattle, right? Seattle is accelerating, San Francisco is decelerating. Are you feeling that in the market at all?

I think I said in the last call that, or maybe at NAREIT, that I don't expect San Francisco to grow at the rate it's been growing at because there's frankly no place -- there's very few places for people to go right now, so Seattle, what it's got is it doesn't have these kooky Prop M things and all the rest. So they've got a process, which is pretty exact in knowing what you -- you can forecast what you are going to get in a year. You don't have a big drama to get entitlements.

And, of course, the cost of living in Seattle is lower than it is here in the Bay Area, so that's attractive. And you are seeing companies go to where they can get employees and the kind of employees they want. In some markets, it's a different kind of employee, but nevertheless an important one.

What you see in this area is a lot of the engineers and so forth that are key and vital to the long-term success of the products and whatnot, they want to aggregate here. You know, it's -- LA a few years ago wasn't growing at all. Now it's growing. San Francisco was kind of kicking everybody's tail and it's still doing very well. We've seen good -- fairly good mid to high growth this year in San Francisco. In the fourth quarter of 2016, San Francisco grew at 1.9%. The 2017 forecast is sort of 3%, but, again, that's across the market. The higher-quality stuff just south of Market has been growing at far greater rates. Silicon Valley in fourth-quarter 2016 grew at roughly 3.5%. The forecast is sort of right around 3%-ish or whatever. Seattle grew at 3.6% in the fourth quarter and the 2017 forecast is, again, sort of low to mid single digits. I personally think we're going to blow by that hugely in Seattle because of the demand and a positive product.

So -- excuse me, I was giving you job growth. I misspoke. The San Francisco forecast for 2017 is 3% to 5%. Seattle is 4% to 6%. Los Angeles is kind of 5% to 8% on the Westside and 10% in Hollywood and West Hollywood. San Diego is sort of 3%-ish. I misread. I was showing or speaking of job growth before.

So, we are seeing good job growth, we are seeing good rental growth, we are seeing good demand. There's just not any product. You know, the thing that people were thinking was a big bogeyman here six months ago or nine months ago was sublease space. Well, it went up to 2.5 million square feet of spec, down to 1.7 million, 1.8 million square feet with only three spaces bigger than 50,000 feet. There's no place for anybody to go.

So you're not going to see the growth in San Francisco for one reason -- there may be others, and that is there's no place for them to go. That's why I love the Flower Mart. Flower Mart is going to be the killer project in the last 30 years in San Francisco. And I can tell you that every sovereign wants to venture that with Kilroy. I don't know about every, but a lot.

Great. Thanks, John.

Jed Reagan.

That's actually a good segue for me. I was just going to ask about the entitlement process at Flower Mart, if there's any update there when you hope to have some resolution, potentially.

Jed, as we've said before and you know, Flower Mart was in the central SoMa area plan, which is progressing. No project can get approved with more density until that plan moves forward.

The city has recently come out. They finally did release the draft EAR end of last year and they've recently said they are expecting that to be certified sort of in the Q3-ish timeframe, plus or minus, 2017. We've seen those things move a little bit. We are more assuming sort of Q4, plus or minus, so we are tracking along with that. We are doing all the things we need to do to run concurrent with the area plan processing. And we'll be ready for it.

So once that goes through, there will be some other specific zoning requirements that will happen over the next quarter or two, so it's probably not until that late 2018 timeframe when you could really start to submit the permits and move forward. So I think it's much of the same as you've heard from us. The good news is the city is moving the process forward and we are working concurrently with them.

That's helpful. Maybe just another timing question, just as far as the ongoing discussions at The Exchange. Can you give a sense of when you expect those negotiations could conclude or is it just too early to kind of peg that?

Well, it wasn't a curveball, per se, but assuming we do the deal with the tenant we're talking about, we've now introduced a venture which wasn't part of the letter of intent, so we are working through that. We have a number of meetings for the very senior people and board members on it.

So, it is not an entity that moves at the speed that Kilroy does. There aren't many entities that do that. We said before that we thought we'd get board approval on the deal, assuming they were going to approve it, which would be sort of end of the first quarter, early in the second quarter. I kind of think that's probably kind of still as good as any. We'll know more as we -- we've been meeting to go through this venture stuff, and with lease accounting and the commitments they are making and the strategic nature and all the rest and the fact that they've got cash on hand and all the rest, they just decided they should own a piece of it. And it works out great for us, assuming we do the deal that we'd want to do, and more to come.

Jed, I've got to tell you something. When I go back to when we were dealing with DirecTV and they were in possession of part of the space and they needed it and so forth, and everybody and all the board members and everybody else, you know, it's really important, it's really strategic to us. We want to really move quickly, and it took 2.5 years.

This isn't going to take 2.5 years. We're not going to wait then. We are going to end up with all the necessary things you look for, pulse, smile, eye contact, body motion, documentation, all the stuff that you kind of interpret as being positive towards a conclusion as quickly as we could do it. Or we're going to go a different direction.

And I got to tell you that there are a lot of people talking to us about Hooper. They've got no place to go because they are not going to go in a high rise. There are a lot of people who like high rise; there are a lot of people that don't. We've got all the product, I think, in the market right now that's not high rise.

Appreciate that. And can you just talk a little bit about the concession environment in your markets? Are you seeing any upward or downward pressure on TI packages in your markets?

This is Rob Paratte. I would really say there's no change. Demand is up, but, as John said earlier, supply, there's just not a lot of supply.

So I think landlords in general have a little bit of wind behind their back. But, you know, we are not -- [increases] in CapEx and that kind of thing, and, frankly, a lot of these tech companies are sitting on so much cash, they are putting a lot of their own money into the space.

Okay, great. And then just last one for me, if I can. In terms of the West Hollywood acquisition, do you see that as likely a one-off investment in that submarket? Or do you think there's an opportunity to build some real scale there?

David, go ahead. It's a small market.

Yes, it's a small market, Jed. You know, I don't know if you are familiar with it. When you think about that West Hollywood market, you've got a mile and a half on Sunset Boulevard and probably the best strip of Sunset, with Beverly Hills bordering on one side and LA on the other.

Only about 600,000 square feet. There's a couple of really quality buildings, our project being one of them, 9200 Sunset. You know, it would be great to acquire some of these other ones because it's been a historically high occupied office market, given the affluence in the hills and all the adjacencies around there. It's pretty sought after. I find it unlikely that we'll be able to pick off a lot of stuff in that market, but we like it and we're going to stay very close to it and we know it really well.

Okay. Thanks very much.

John Kim.

Thanks, good morning. I wanted to ask a couple questions on your return requirements for acquisitions. It sounds like, on the recent ones, you can get to a 7% yield. I'm just wondering how much CapEx and time it takes to get there. And second of all, to get to that 7% yield, does that mean that the -- you can get to a similar IRR as you can on ground-up developments?

Who the heck knows on the GAAP side of it? On 7%, this is not easy stuff. This is -- the first one that we owe, the West Hollywood one, they did what they could within the resources they had and so forth. This was in a private equity group that was a fund. It was, I think, the last asset or one of the last assets to be sold.

And then, we're going to put more money into it. Therein lies the opportunity. Because it needs to be -- we brought in retail consultants and David is working with them and his team to reposition retail, the signage, the parking, etc., etc., the office space. So we think we'd get there. Does it take three years? Does it take five years? We'll see. Because this is hard stuff. This is not -- this is the hard stuff to do, okay?

The deal up in Page Mill, it's the fact that the rents -- I mean, you have a fabulous product. You got the bigger of the two buildings, the Theranos. I'm not going to comment about that, but the buildings we bought are well below market. There's a lot of demand in the research park. A lot of the autotech people and others want to be there. Life science wants to be there. The Theranos building is the best building in the park. I have no question about that. It's got all the Kilroy magic and all the quality stuff and finishes and ceiling heights and all the rest, and Tracey says it's like the perfect plug-and-play for somebody in the life science industry or you can do, because it's about 20% lab, isn't it, Mike?

Yes.

So that's just an opportunity, an arbitrage, essentially, between the current market rent and the -- the current rent that we are getting and the actual market rent. Of course, you've got to get to the building. The smaller of the two, I think it comes up in three years. And only the renewal will reposition, so that will move up. And that's roughly 25%, Tyler? The revenue? I can't recall. 20%, something like that. And then, the Theranos thing, we'll see what happens.

Okay, on the tenant incentive side (multiple speakers)

By the way, on the whole GAAP thing, obviously we could do a development deal and you do a long-term lease, your GAAP rents are generally going to be pretty good because just the nature of 3% or 4% per annum compounding, right? And when you do other leases that are five, six, seven years, you have more opportunity to play the market, whether that's good or bad, depending upon when leases expire, but you don't have that GAAP impact that you have by the longer leases.

Understood, okay. On tenant incentives, I understand the market is not moving that much, but on your metrics on what you reported this quarter, it did go up significantly for you on a per annum basis, and I'm wondering if this is related to a particular market or perhaps a tenant type where this would increase.

Tyler, you want to cover that?

This is Jeff. So it was primarily driven by one transaction. That's the Amazon 12-year deal up in Seattle. So, we had prior space was [ad van], and so we've converted to creative space. So that's where the TIs were a little bit higher, but consistent with a 12-year lease, we feel really good about the data points.

Got it, okay. And then, one of your office REIT competitors recently acquired a development site in Oakland, albeit on the multifamily side, but can you provide an update on how attractive that market is for you and where it is on your radar screen?

It isn't.

Do you want to elaborate?

No. I think that's pretty firm.

Okay, thank you.

Tom Catherwood.

Quick one from me. As you guys look to expand your life science platform, how do you think or approach building out or supplementing your underwriting program as it relates to the life science tenants and their notoriously kind of volatile drug development pipelines?

That's a really good question, Tom, and that's the reason we asked and thankfully, successfully, brought Tracey Murphy aboard. As I said earlier, she's got a terrible cold and a strep throat and all the rest, so she is far more qualified to speak to that than we are. But we've brought in folks that she's worked with for a long time that are top notch in underwriting in the analysis.

There's obviously -- when we talk a bit to a lot of the tech crowd, we show them the floor plates. We show them the environment. We show them all this stuff. When you talk to the life science crowd, you don't show that stuff. You talk about MEP and you talk about floor loading and you talk about all that stuff. It's a total -- the Greeks speak a language and so do the Englishmen. It's just that they can't understand one another.

And that's a little bit -- I'm being a little bit dramatic here, a little bit too black and white, but we brought in the resources that we think are necessary on the construction, on the design; obviously, the vendors and whatnot that we work with are all specialists in life science -- in the underwriting capability, and then, of course, to lead it all is Executive Vice President Tracey Murphy, and I think we've done the things that are necessary to make sure that we are delivering product that has life beyond tenants. It's not ultra-specialized. It has the appropriate bells and whistles and so forth.

And frankly, you know, she's been very helpful with regard to The Exchange and we set that building up to go life sciences to begin with, but she has brought with her in her toolbox a bunch of tools that we didn't have. So, I hope that's not too long an answer, but I hope it answers your question.

That's perfect. Thanks, John.

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

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

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