Kilroy Realty Corp (KRC) 2019 Q3 法說會逐字稿

Good day, and welcome to the Third Quarter 2019 Kilroy Realty Corporation Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Tyler Rose, Chief Financial Officer. Please go ahead.

Good morning, everyone. Thank you for joining us. On the call with me today are John Kilroy and several other members of our senior management team, who are all available for Q&A. 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 8 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 an update on our markets and a review of the third quarter. I'll provide the financial highlights and discuss our updated 2019 earnings. Then we'll be happy to take your questions. John?

Thank you, Tyler. Hello, everyone. Thank you for joining us today. I'll begin with a quick overview. In summary, our markets remain strong. We've made significant leasing progress in both our stabilized and development portfolios. We were successful in acquiring 2 strategic value-add properties, and we improved our balance sheet.

From San Diego to Seattle, the supply and demand fundamentals of every market we compete in remain sound with low vacancy rates and increasing rents. With these favorable conditions, we signed approximately 1.3 million square feet of leases in our stabilized and development portfolios since the end of last quarter. This includes 421,000 square feet with Stripe at Kilroy Oyster Point that we announced this morning.

We are on track to have another great year on top of our record leasing last year. Our stabilized portfolio is now 97% leased. We commenced construction on 2100 Kettner, a $140 million office project in the Little Italy neighborhood of San Diego. We completed 2 acquisitions totaling $226 million, both provide attractive future redevelopment upside. We maintained a sharp focus on balance sheet, raising $616 million through the pending sale of 1 building and the issuance of public bonds, and we continue to build a world-class sustainable enterprise.

We were ranked #1 in sustainability across all publicly traded real estate companies in the Americas by GRESB for the 5th consecutive year. The EPA has awarded us the highest honor of sustained excellence for the past 6 years, and NAREIT has recognized us as a Leader in the Light for 5 years running. Further, we are on track to be carbon-neutral operations by year-end 2020.

Now if I can get into the details. First, we signed 550,000 square feet of leases in our stabilized portfolio since the end of last quarter. Cash rents on these leases were up 19%, GAAP rents were up 40%. One set of transaction provides a good example of how we are leveraging our existing assets and development skills in today's strong markets. In Del Mar, we signed 2 leases with existing tenants that both expanded to take approximately 300,000 square feet in the aggregate, where the change in cash and GAAP rents averaged 20% and 50%, respectively. These properties are in close proximity to our new One Paseo mixed-use development, and both have benefited from the amenities, public spaces and cohesive character that the development of One Paseo has created.

Across our development portfolio, we signed 710,000 square feet of leases since the end of the last quarter. This includes a lease for 421,000 square feet that we announced earlier with Stripe for a term of 12 years. With this transaction, our $560 million Phase 1 is now fully leased just 7 months after construction commencement and roughly 24 months earlier than scheduled. We have exceeded our initial underwriting on this project, both on a cash and a GAAP basis.

Our strong leasing performance extends to One Paseo as well. The office component is now 70 -- 76% leased while the balance of the space is in negotiation, and the retail component of One Paseo is 100% leased. We delivered 237 residential units at One Paseo in mid-September. More than 1/3 of the units are already leased. We're also active in negotiations at our 9455 Towne Center Drive development in San Diego. The 160,000-square-foot project located in the UTC submarket is being developed to accommodate both life science and life -- excuse me, both life science and nonlife science users. The strong location and highly amenitized state-of-the-art environment is attracting interest from a range of media, tech and life science companies. We expect this to be well leased before shell completion mid-next year.

Given our strong leasing success, we commenced construction on 2100 Kettner, which is located in the Little Italy neighborhood of San Diego. This is a 1.2 acre full city block in one of San Diego's most popular neighborhoods for young professionals. It is 2 blocks from the harbor, surrounded by restaurants, retail and other amenities and within close proximity to public transportation and the San Diego airport. We're developing a 200,000-square-foot modern office and ground floor retail space in a brick-and-timber low-rise design. Our incremental investment is roughly $100 million with core and shell completion scheduled for the first quarter of 2021. Excluding 2100 Kettner, where construction just started, the office and life science component of our $2.2 billion development program under construction is now 90% leased.

Upon stabilization over the next 3 years, the 6 projects under construction, which includes 2100 Kettner, One Paseo office and residential, Netflix and Living On Vine, 333 Dexter and 9455 Towne Center Drive and Phase 1 of Kilroy Oyster Point, are estimated to generate a total cash NOI of approximately $150 million. Approximately 85% of this NOI will come from office and life science and 15% from the 564 residential units at Phases 2 and 3 of One Paseo Living -- at One Paseo rather, and Living On Vine.

Now for a few comments about our development pipeline. At Kilroy Oyster Point, we recently submitted the precise plan to the city of South San Francisco for the second, third and fourth phases of the project, totaling approximately 2 million square feet. This process takes about a year, and we currently estimate we could start any one of these phases in 12 to 15 months, subject to the right market conditions.

And at the Flower Mart, we're happy to report that the 4 CEQA lawsuits affecting the entire Central SOMA area are now resolved. We're close to executing the development agreement, which would position us to commence construction as early as 2021.

In looking to the future, we've added 2 redevelopment projects to our future pipeline that will provide significant earnings and value growth over time. The first is the fully leased Blackwelder creative office project in Culver City submarket of Los Angeles. We paid $186 million for 158,000 square feet of fully leased office buildings situated on a 6.9-acre land site. The campus currently consists of 19 1- and 2-story buildings leased to creative tenants with average in-place lease term of 39 months. In-place rents are approximately 35% below market. We have the optionality to significantly increase the project square footage through redevelopment over time.

The project has terrific locational advantages, first is transit. Blackwelder offers multiple transportation options. The Metro Expo Line is about a 5-minute walk from Blackwelder and provides a 20-minute ride to Santa Monica and 25-minute ride to Downtown Los Angeles. Freeway and airport access is also excellent. Second, Blackwelder is in close proximity to the Hayden Tract in Downtown Culver City, which offers an abundant range of new commercial, retail and residential amenities. And immediately adjacent to Blackwelder is the Cumulus project, which is under construction and is scheduled to deliver in 2021.

The Cumulus encompasses 1,200 residential units, including a 30-story residential tower, 100,000 square feet of retail space, which is 40% leased to Whole Foods, and a 1-acre public park. We're very excited about our entrance into Culver City. Much like Hollywood, it has become a magnet for LA's young, creative professionals and the companies for whom they work. Major media content producers in the area now include Amazon, Apple, HBO and Sony Pictures. Amazon and Apple alone are expected to occupy a footprint of approximately 1.5 million square feet in Culver City in the near future.

Creative Class A space vacancy in the market is 2%. All new development projects in the area, roughly 1.6 million square feet of office, have been substantially leased prior to construction completion. The second future development -- redevelopment project that we acquired is located in the East Village submarket of Downtown San Diego. East Village has become one of the most vibrant and sought-after neighborhoods in Coastal San Diego that is increasingly attractive to the city's large and growing millennial population.

We paid $40 million for a 2.3-acre fully entitled mixed-use site. The prior owner will be leasing back 3 existing buildings through mid-2021. During this time, we will be evaluating the appropriate mix of uses for this site. We envision a project reflective of the neighborhood's urban mixed-use character, including rooftop decks and balconies, street-level retail and ground-level open space.

One of the things that attracted us to the East Village is the availability of housing. Over the past 5 years, 4,500 new residential units have been delivered to this area with another 3,000 under construction and another 2,500 units in planning review. Retail and cultural institutions, including Petco Park, home to the Padres baseball team; the new San Diego Central Library; University of California San Diego's new extension campus, have quickly followed. Employers attracted by the young, well-educated workforce are boosting demand for modern office space in this market.

The East Village reminds us of what SOMA looked like 10 years ago. There's a similar vibe and character. A big difference is that the East Village has significantly greater availability of residential, and it's far more affordable.

Let me close with some summary thoughts. Market conditions remain strong and highlight the value of our stabilized portfolio, which is monetizing market strength in the form of significantly higher rents. Development continues to be a major value creator for KRC. We believe that our patient, disciplined and creative approach to new development adds a meaningful premium in the returns we can achieve on projects as varied as One Paseo, 333 Dexter, Kilroy Oyster Point and the Flower Mart, to mention just a few. Not only are we achieving greater returns, but we're creating the most advanced work environments in the country. And with all this activity, we're doing it in such a way that continues to place balance sheet strength and financial flexibility at the core of our business strategy.

That completes my remarks. I'll turn it over to you, Tyler.

Thanks, John. FFO was $1.01 per share in the third quarter, driven by strong core results, $0.03 of one-time items and the impact from our disposition and recent bond offering. Same-store cash NOI grew 3.6%, and GAAP NOI increased 8.3%. Cash same-store NOI growth was primarily driven by the burn-off of free rent at a few San Francisco and Seattle properties. The increase in GAAP same-store NOI was driven by commencement of new leases, also largely in San Francisco and Seattle.

At the end of the third quarter, our stabilized portfolio was 92.1% occupied and 97.3% leased. With our strong leasing activity through the first 10 months of the year, we've effectively addressed all 2019 lease expirations with just 64,000 square feet remaining and have a manageable 2020 expiration profile of 774,000 square feet or just 6.4% of the portfolio. We only have 1 expiration greater than 100,000 square feet in 2020.

We estimate that our portfolio-wide weighted average in-place rents remain above 21% below market. By region, in-place rents for San Francisco are approximately 33% below market, Los Angeles and Seattle's are 10% below market and San Diego's are about 9% below market. Our 2020 lease expirations are estimated to be 17% below market.

Now let's move to the balance sheet. In July, we drew down all the proceeds from the sale of 5 million shares of equity we issued in 2018 on a forward basis. The roughly $90 million of forward equity issued in the first quarter under the ATM remains undrawn at this time. We intend to draw this down in the first quarter of 2020.

We raised $500 million of 10-year bonds at 3.05% in September. We're in escrow to sell our only Orange County building for proceeds of $116 million, and with these transactions, we have substantial debt capacity and flexibility. Prior to drawing the ATM, we'll have approximately $150 million of cash and $750 million of capacity under our bank line and an incremental $600 million under the accordion feature. We have a large unencumbered portfolio with only 2 mortgages, very little floating rate debt and no significant maturities until 2022.

Our debt to market cap at quarter end was approximately 28%, and our debt-to-EBITDA was approximately 6.6x, adjusted for the remaining equity forward transaction. We expect our debt-to-EBITDA to come down as our lease development projects come on stream.

Now let's discuss our updated guidance for 2019, provided in yesterday's earnings release. 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 on market intelligence as we know it today. Any significant shifts in the economy, our markets, tenant demand, construction costs and new supply going forward could have a meaningful impact on our 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 occupancies.

With those caveats, our updated assumptions for 2019 are as follows: We forecast remaining 2019 development spending of $125 million to $150 million. Our forecast for year-end office occupancy remains at 94% to 95%. Given the recent commencement on some of our leases in San Francisco and Seattle, we are increasing our projected 2019 GAAP same-store NOI by 50 basis points to 3.5% to 4.5%, and our forecast for cash same-store NOI remains flat for the year.

Last quarter, we provided updated earnings guidance for 2019 of $3.67 to $3.78 per share with a midpoint of $3.73 per share. Heading into the fourth quarter, there are many moving parts. Given the strong results in the third quarter, the 2 recent acquisitions, the timing of our disposition, the benefit of our recent bond offering, we are increasing and narrowing our range to $3.82 to $3.88 and increasing the midpoint by $0.12 to $3.85 per share. This midpoint would imply a fourth quarter FFO per share of $0.94, which is $0.07 lower than our third quarter results, primarily driven by the downtime associated with Dropbox expanding into The Exchange and moving out of 333 and 345 Brannan, a full quarter of interest expense from the new bonds and the disposition.

As a reminder, we are projecting revenue recognition at 333 and 345 Brannan by the end of the year. That's the latest news from KRC. Now we'll be happy to take your questions. Operator?

(Operator Instructions)

The first question comes from Nick Yulico of Scotiabank.

First off, on Oyster Point, congrats on getting that lease done with Stripe. Can you give us a feel for the rents on that deal? I know you talked about the overall first phase project has now exceeded underwriting, so I imagine you're getting higher rents for the office than for the lab there.

Yes, I don't want to get into specific rents on specific deals, Nick. Let's just say that of our office and life science across the board that I mentioned in our earlier remarks, we are continuing to be in the very high 7% or better ROCs. Most of these leases are 10 to 15 years throughout the ones we've mentioned, and they typically have 3%, 3.5%, 4% annual bumps. That's about as good as I can give to you.

Okay. And as we're thinking about, though, future phases of Oyster Point, your desire to do office versus lab there. I mean, does this mean that the overall yield on this whole project could be higher for the future phases if you were to do more office? Are you looking to do more office there?

I don't want to get into predicting what the yields in the future are going to be. I mentioned when we underwrote this thing, we were looking in the early to mid-6s. We've done quite a bit better than that. I think we'll do better in the other phases, obviously, subject to market conditions. As it relates to tech versus life science, I'm sort of agnostic. We do what we think is in the best interest of our shareholders, and we have the unique situation with the product and the environment that we've created at Kilroy Oyster Point. Remember, we have 40 acres plus a 10-acre Marina. So we have something that nobody else has. We have extraordinary views, the ferry service, et cetera. I think this is going to be a blockbuster project. I think it's going to appeal increasingly to tech as well as to life science, and we're working with many people in both camps.

Okay. And just last question on Culver City, the acquisition you did there. Our understanding is that there were a lot of people looking at that project. You ended up getting it. There's this densification potential there, which is the Tract. Can you talk a little bit more about how much square footage you could ultimately build there and how we should think about when this could become a -- is this a new development? Is it a redevelopment of existing space? And do you have to wait the full 39 months on the lease term to get the project started? Or would you think about being able to get tenants out earlier?

I don't want to talk about that. I think talking about strategy with tenants and with competitors is bad to do on a telephone call. We do have a -- we're looking at early stages of looking at what we might be able to redevelop the project to over time. It would be many, many times the square footage that's there now. In the meantime, Tyler, do you want to talk about the yields on that project?

I think over the next -- excuse me, I'll do it. Over the next 3 or so years, we think we get to north of maybe a high 6. And we're going in right now in the mid-3s on a ROC basis. And that's not -- excuse me, that's not allocating any value to the future development.

Okay. And then just 1 last question on the onetime items this quarter. I think, Tyler, you said it was $0.03. Is that all in NOI? As we're thinking about just a clean run rate on NOI going forward, is the $0.03 all should be stripped out of NOI this quarter?

Yes. Yes, it's related to parking and some common area maintenance true-ups, but yes, it's in NOI.

The next question comes from Craig Mailman of KeyBanc Capital Markets.

Maybe Tyler, just sticking on guidance. So if we think -- there's a lot of moving parts, you guys are up $0.12 over last quarter. Kind of stripping out that $0.03, you're at $0.09. How much of that was just the recurring kind of upside from 3Q versus some of these other moving parts on acquisitions and commencements and other things?

Yes. I mean, if you break down the $0.12, roughly $0.07 of that is core and noncore. The noncore I just went through. So the core is about $0.035. And then the acquisition is accretive initially, and the bond transaction is later and lower rate than we had anticipated. So that's the other difference.

Okay, that's helpful. And I know, John, you said kind of 3.5% going in on Blackwelder. What's that when you assume kind of the FAS 141 impact for the below-market leases, so on a GAAP basis?

Tyler, do you want to take that?

Yes, it's about mid-5%.

And then, John, you had mentioned the CEQA lawsuits are kind of done for the Flower Mart. In the past, you kind of said you wanted to hold off on leasing there until the lawsuits are done. Could you give an update on prospects there, maybe potential timing on a pre-lease before you go forward?

No. I won't for competitive reasons.

Okay, that's fair.

The next question comes from Jason Green of Evercore.

How should we think about the remaining Dropbox space at The Exchange coming on? You're at 52% now. How much does Phase 2 in Q1 of '20 and Phase 3 in 3Q of '20 add to that 52%?

Jason, it's Michelle. Dropbox at The Exchange is scheduled to come online. The rest of it towards the end of the year in -- by December.

Okay. And just to be clear, on the disposition side, the $150 million that -- I'm sorry, the $150 million that's not in guidance right now, is that expected in fiscal year '19 or is that a fiscal year '20 event?

The disposition, we're in escrow to sell a project for $116 million that should be closing any day. We sold a property earlier this year for roughly $20 million, so that's roughly $135 million. That's the dispositions that will complete in 2019. We haven't given 2020 guidance yet on dispositions.

And Jason, just to clarify in terms of the Dropbox at The Exchange, there'll be on Phase 2 roughly 50,000 square feet coming online by the end of the year. And then the remaining phase will be coming online towards the middle of the year, next year.

The next question comes from Manny Korchman of Citi.

You guys have had a busy acquisition market, or been busy. What does the acquisition pipeline look like right now going forward, if you could?

Yes. We don't have anything with regard to existing buildings per se that we're -- we evaluate everything. We're not in negotiations on any existing buildings. We're looking always if we're missing something. As I've said in prior calls, I don't see us buying a lot of existing buildings. The exception would be something like a Blackwelder, where it's an okay going-in return, but it has significant redevelopment potential for the future. I like that. Just buying core, not interested.

And then you talked about the 2020 lease rollovers for that large space, the one over 100,000 square feet. What do the prospects look like there or the prospect of retention of that tenant?

Manny, it's Rob Paratte. So we have a year -- a little bit over a year left before that vacancy occurs, and we're already in discussions with people on it. We've had some good leasing activity on current vacancy we have with the project. And then lastly, I would say, we're undertaking a mild refresh of the project itself, lobbies, landscaping, that sort of thing, same thing that we did at Sabre Springs and Del Mar Corporate Center, which we think will help us push rents and fill the space.

Where is that one, Rob?

Long Beach.

Was there a follow-up, Mr. Korchman?

No.

The next question comes from John Guinee of Stifel.

Great. Nice job, guys. Tyler, about 1.5 years ago in New York City in June, I think at NAREIT, you had an Investor Day. And you gave kind of a soft guidance of late 2020 FFO at about maybe $4.50 a share. How do you feel about that?

You ask me that every quarter. It's getting to be a tradition, I think. But -- yes. And I think the answer is that if you were to go back in time and everything had played out the way we had thought it might that -- at that point, we'd be very close to that number. Obviously, with less dispositions and more acquisitions and bond deals at different timing and larger size, that number would change. But I think the answer to your question is, yes, we would still be on track if everything else stayed the same.

Did everything stay the same? And are you still on track?

No. Nothing stayed the same.

So higher or lower?

We're not going to comment on that. We'll provide guidance on our 2020 numbers next call.

The next question comes from Derek Johnston of Deutsche Bank.

What are your thoughts on how antitrust and potential regulatory actions on FANG companies could impact their demand for office space?

Derek, it's Rob Paratte again. That -- we can't predict what the outcome of these various actions that are in the news are going to have on these companies. But given the day-to-day conversations we have with all of them, there's no cessation in their demand for space, particularly on the West Coast, but you're seeing their demand also in New York and other areas like Austin. So thus far, and will it affect 1 company more than another? Hard to predict. And what the ultimate outcome will be? Hard to predict, but we're seeing a lot of demand and continued growth in all of our markets.

Okay, great. And there has been a fair -- it's interesting you say that -- amount of debate about accelerating leasing demand in New York City from the tech or the expanding FANG companies. Does this concern you guys at all? And would you ever consider maybe a build-to-suit project in Manhattan or even other markets with your partners?

We've been asked, but we haven't done it. And I don't think that New York City really needs Kilroy.

The second part of your question, does it concern us? Not at all because they're growing -- as much as they're growing in New York, they're growing in Seattle, they're growing in San Francisco Bay Area. They're coming to San Diego. It's a unique time right now.

And the other side of that is everybody likes to focus on the FANGs because they've sort of been in the press lately. But the number, what was the number, 149 or something unicorns in the Bay Area. Don't hold me to these numbers because I'm just trying to remember what the article was. But it's -- the number of new companies that are growing sort of exponentially in the Bay Area is something I've never seen before. It's -- and it's because these folks are all coming here because of the ecosystem. And any time you pick up a newspaper, there's always another one. So there's a lot of folks out there demanding space way beyond the FANGs.

That's good color. And then just lastly for me, I think there's been some pretty well-documented chatter about Prop 13 making its way to the ballot again next year. You guys have a fairly young or new portfolio. How do you view that? I mean, seriously, you're closer to it on the ground. What do you think about that?

Do you want to cover that, John -- or Tyler?

Yes. Obviously, we're watching that, watching the polls and how that might play out. The vote is next November. If it passes, which it's not necessarily going to pass. But if it passes, it will take several years to sort of get implemented. What we've said previously is, initially anyway, for us, it's a $0.02 to $0.04 hit. As you point out, we have a fairly young, new portfolio. So it doesn't impact us initially as much over time.

The next question comes from Jamie Feldman of Bank of America Merrill Lynch.

I guess, John, kind of sticking with your comments on the San Francisco unicorns and growing companies there. I mean, we've seen a little bit of a hiccup here in the tech IPO market or the IPO market in general. Have you seen any change in mood or sentiment or cash or investment flows in your West Coast markets?

Jamie, it's Rob Paratte again. We're not seeing any change. In fact, Q3, there was $26 billion of VC funding nationally. 60% of that came to the West Coast, and 20% of that came to life science. So we see a very -- and that's on par with -- very close to Q2 of 2019. So we're not seeing any let-up in that. And as John said earlier, the amount of young, growing companies in the Bay Area and elsewhere, frankly, is truly astounding right now.

Okay, that's helpful. And then have you seen any change in either the tenant demand or different coworking operators looking for space since WeWork pulled its IPO?

Well, there's always been -- there's the Knotel Group. There are a number of other competitors to WeWork. They're always looking for space and so forth. I want to make it clear to everybody on the call that Kilroy has -- I think it's something -- Michelle, correct me if I'm wrong, but it's well under 1%. I think it's under 0.5% exposure to coworking. We've not been a big fan of having that kind of tenant in our buildings in scale. But just to comment about WeWork, there's been a lot of speculation in the press and whatnot, what does this mean? Now it's going to mean different things in different cities, I would guess. But if they give any of that space back, their space is terrific space. It's total plug-and-play for most of the tech companies. So we'll see what happens with those guys.

Okay. And Tyler, I know you ran quickly through some of the financials here. But I guess, as we just kind of think through the next year or so, can you just walk through kind of sources and uses of funding?

Yes. So in terms of spending, as I said, about $125 million remaining this year and roughly $500 million or so next year, assuming nothing else happens. And in terms of funding that, as I said, we'll have $150 million of cash. We have $90 million of ATM. And we're looking, obviously, at doing dispositions next year. And we have debt capacity and other capacity to do ventures equity. We leave all the doors open, and we'll evaluate it. But more than half of it is funded today. And we'll -- as we always do, we'll be selling properties and doing other funding next year.

The next question comes from Blaine Heck of Wells Fargo.

Can you guys talk about the type of tenant you guys are targeting at 2100 Kettner? Any early indications of interest you guys are seeing there? And just in general, what factors made you comfortable going ahead with spec development in that market?

Well, the market is just an incredible market. It's very supply constrained. It's where a lot of the housing is, it's where the millennials want to be and the tech companies and so forth to support that. I don't think you could find a better location other than maybe One Paseo office now because of the One Paseo retail and residential. So you just couldn't ask for a better site and better market conditions than what we have there. Also, the product that we're developing, it's low-rise, what is it, Rob? 5 stories, roughly 200,000 feet with ground floor retail, brick and timber, high ceiling heights, lots of decks. I mean, it's the bee's knees, if I can use that expression, in an office space. In terms of the user crowd, we have all kinds of people that are interested in the building or portions of the building. We won't quote a rent at this point. Rents are going up. One Paseo rents have set new highs. We have some other things going on we think are going to set new highs. And we just started construction. That thing delivers, what, the end of next year, Rob, or maybe stabilizes 2021. Is that right, Eliott?

Yes, 2021.

So I don't want to quote a rent at this point, but I think it will be a record breaker.

Well, to follow up on that, and not to get into specific rents, but maybe for Rob, I guess, where do you think market rent growth could shake out in San Diego, and I guess, more importantly, in the submarkets you guys operate in over the next 12 months? I mean, are you seeing growth there that's getting closer to your other major markets at this point?

Yes, we are. I mean, San Diego rent growth is 9.2%. I mean, I've undershot my rent growth projections the last few quarters. So I think particularly with folding in what John said about the unique character of 2100 Kettner, rent growth above 10% is not going to surprise me. Again, it really -- it's one thing to be in the markets where the tenants want to be, but it's also building this type of product and collaborating with the tenant/clients that we deal with. And to answer your other question, there's a lot of interest from different categories of tenants, whether it be tech or some professional service firms, that sort of thing.

The next question comes from Dave Rodgers of Baird.

Yes, Tyler, maybe to start on the accounting side with you, if I could, quickly on The Exchange. Can you talk about the capitalization of interest there and kind of how you see that burning off through the final phases of occupancy?

In terms of the actual numbers, I don't have the numbers. But I mean, as Michelle said, we'll be fully completing capitalization by mid-next year when Phase 3 comes online, and we'll be reducing cap interest at the end of this year when Phase 2 comes online.

Yes. And we expect cap interest for the year to be in that roughly $80 million. So it's in the similar run rate to second quarter and third quarter.

And is that just the lower capitalization from mix change, offset by the added development projects?

Correct.

Okay. The fees in the quarter, I think you had mentioned some time ago, some restoration fees from Dropbox. Have you recorded all those or will you get those later? Would those bleed into '20?

Yes. Those have all been amortized into our numbers.

Okay. So still collecting them on a GAAP basis. And then the downtime, the...

Just to be clear, they've been amortized. So we've collected all those and -- they're all done. Yes.

Okay. You mentioned the downtime, I think, at the Brannan Street assets, Tyler, with the move-ins and move-outs. But it sounds like that downtime is literally limited just to the fourth quarter this year.

That's correct. We expect Cruise to move in, in December. So there's effectively 2 months of downtime.

2 months. Okay. Maybe last just to John and as a follow-up on Tyler's comments earlier about funding. You had talked for a number of quarters about larger joint venture sales. It doesn't sound like that's off the table, but you kind of didn't mention it overtly today. Can I just ask about kind of any progress that you might be making there? And if that's still kind of a main avenue for you in the future?

It's certainly an avenue, and it's certainly something that we keep abreast of and talk with folks all the time in specifics. But right now, we don't have anything that we are negotiating in detail. And with the leasing we're doing and so forth, I kind of feel that if we're going to do a venture on a development project, it's probably a lot better to do it when you have a lease in hand rather than when it's spec, because the differential in thresholds for IRR and so forth are a little bit different. But it's certainly a source that we look to for the future.

And we have a follow-up from Manny Korchman of Citi.

It's Michael Bilerman here with Manny. John, congratulations on the Oyster Point Stripe deal. I know they still have like 8 years left on Townsend. Are you involved at all on their potential sublease of that space or providing them any compensation for a lease termination payment? Or is it solely they're going to deal with that and they'll move in, in 2022 to your space?

It's the latter. We have no exposure.

And then are you going helping them at all in the sublease or you're -- that's not even like a service that you'll provide for them?

They haven't asked us, and it's not generally what we do. So I don't know -- I don't contemplate us being involved in that at all, Michael.

Okay. And then just stepping back from it, clearly, at least from what they're trying to put out there into the press is, one of the big desires for them to move down to South San Francisco is just the need for space and the ability to grow, which is quite limited right now in San Francisco, which is great from a rent perspective for you and great for you to lease-up your developments in San Francisco proper. But does it concern you at all if tenants feel that they can't expand in the city and/or have to pay exorbitant rent to get space? Is this a trend potentially that others may go down and seek alternatives to the San Francisco market?

Well, Michael, it's a big question. And certainly, I don't see it as a trend. There are companies that move out all the time, but there's many more companies that move in. I don't like the idea. I'm not going to agree with you that they're exorbitant rents. If you look at what these types of companies pay in other markets around the world, San Francisco is in the upper quarter from a percentile standpoint, but it's certainly not anywhere near the highest. So I think there's room to go on rent. As to the availability, now with the CEQA lawsuits solved, we're going to see projects come on stream. I mean, we have the Flower Mart, of course, and Tishman Speyer has their 800,000 or 900,000 feet, 700,000 feet, whatever it is, and so forth. So the problem is, this has just come about with the CEQA resolution.

And people move for various reasons. I'm not going to get into any comments with regard to the recent announcement on our Oyster Point tenant. That is better addressed by them.

Yes, no. And that's -- I wouldn't expect you to comment on that. It's more so thinking about that situation and some reasons that they've put out there in the press as to their move and whether -- as you think about what's happening in the city, whether that could portend to others. But I appreciate your -- the color that you've provided.

Yes. Well, one of the things we're excited about with the Flower Mart, with the scale of that -- and remember, that's -- the first phase is pretty good size. And then there's a second phase that we have the ability to accommodate a large user or a number of large users with the ability to scale up. And frankly, we're seeing that more and more frequently with -- particularly with the big -- the faster-growing companies. If you think about the Chelsea area there in New York, you saw a big user come in, take some space, then take some more space, then take more space, take more space and more space. Well, these folks are growing. And when they put their foot down in a place, generally they put a second foot down and then pretty soon you have a lot more to follow. What we have and what we offer in scale in South San Francisco is almost unprecedented. We have in Phase 2, 3 and 4, roughly 2 million square feet we can deliver and, I think, 8 or 9 buildings, 7 or 8 buildings. So you could think of those as all being a phase unto themselves. And then we have the Oyster Point Tech Center, I think we call it, right next door, which is literally abutting Phase 2 of Oyster Point, where we only have 145,000 feet, and we think we can get it entitled for another 0.5 million-plus square feet as well. So people like -- these companies like to know they can grow. And if you think about it, that was very -- a very big point with our relationship in expanding Dropbox into their new headquarters. We did their first headquarters. And what was it, 3, 4, 5 years later, we did a bigger headquarters, and we didn't have to go to a lender or a partner and get permission and so forth. So we think we have a pretty good program to deal with, frankly, the best working environments and buildings you can develop, in areas with great amenities and transportation. You add to that scalability, you end up with something that's extremely unique.

All right, great. We will see you in a few weeks.

This concludes our question-and-answer session. I would like to turn the conference back over to Tyler Rose for any closing remarks.

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

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.