Kennedy-Wilson Holdings Inc (KW) 2015 Q2 法說會逐字稿

Welcome to the Second-Quarter 2015 Kennedy-Wilson Earnings Conference call. My name is Christine, and I will be your operator for today's call.

(Operator Instructions). Please note that this conference is being recorded. I will now turn the call over to Christina Cha, Vice President of Corporate Communication. You may begin.

Thank you. Good morning. Joining us today are Bill McMorrow, Chairman and CEO of Kennedy-Wilson; Mary Ricks, President and CEO of Kennedy-Wilson Europe; Matt Windisch, Executive Vice President of Kennedy-Wilson; and Justin Enbody, Chief Financial Officer of Kennedy-Wilson.

Today's call is being webcast live and will be archived for replay. The replay will be available by phone for one week and by webcast for one year. Please see the Investor Relations section of Kennedy-Wilson's website for more information.

Statements made during this conference call may be forward-looking statements. Actual results may materially differ from forward-looking information discussed on this call due to a number of risks, uncertainties, and other factors indicated in reports and filings with the Securities and Exchange Commission.

I will now turn the call over to Bill McMorrow.

Thank you, Christina, and good morning, everyone. And thank you for joining the call this morning. We have a lot of information we're going to go through here this morning. But this quarter was one of the best in our history in terms of what we were able to accomplish the acquisition, disposition, financing operations, and asset management side of our business.

First, I'd like to discuss some of the key financial highlights for the quarter and for the first half of 2015, followed by a discussion of the record $3 billion of transactional activity so far this year, and how these transactions will impact the Company in the future.

We will then walk you through our property operations and how our value-add initiatives and asset management have led to improving metrics across the board.

Next we will explain some of the big value creation projects that are happening at the Company, which are not currently reflected in our financial statements or investment account.

Finally, we will conclude by discussing our current financial position and outlook before opening it up to your questions.

Starting off with the financial highlights this quarter, which was the second best in our history, only exceeded by the financial results of the second quarter of 2014. Our adjusted EBITDA for the quarter was $112.8 million compared with $122.2 million for the same period in 2014. Our adjusted EBITDA includes acquisition-related gains of $45.9 million and $52.5 million for the second quarter of 2015 and 2014, respectively.

Also included in our EBITDA for the quarter were gains related to the sale of our Japanese apartment portfolio in 2015, and gains related to the sale of our Irish commercial portfolio in 2014. Excluding gains, our adjusted EBITDA for Q2 more than doubled from the same period in 2014.

Adjusted net income for the period was $63.0 million, or $0.61 per basic share, compared to $64.2 million, or $0.72 per basic share for the same period in 2014. Our basic share count increased over the past year in part as a result of the May 2015 mandatory conversion of the $100 million series A preferred stock held by Fairfax Financial, which converted into 8.5 million shares of common stock. But, going forward, this conversion eliminated $6 million of preferred dividends annually.

Year to date, our 2015 adjusted EBITDA was $166.5 million compared to a 2014 adjusted EBITDA of $191.5 million. To give you a frame of reference as to how far we've come in the last couple years, our adjusted EBITDA for the first six months of 2013 was $68 million.

Regarding our investment transaction activity that we completed with our partners, we had an extremely active quarter and first half on both the acquisition and disposition side. During the quarter, we completed $1.1 billion of acquisitions and $700 million in dispositions for a total $1.8 billion in transactions. During the first six months of the year, we completed $2.9 billion of transactions; the most active six month period in our history.

On the acquisition side, year to date we acquired $2 billion of real estate, roughly 50% of which was acquired through KWE. On average, we acquired income-producing properties at a 7.1% cap rate, adding over $125 million of net operating income to our platform, including over $50 million to KW alone.

During the six months, we sold investments that produced $950 million in gross sale proceeds. On average, these assets were sold at a 4.5% cap rate. We were able to recycle the cash from these asset sales and use the proceeds to invest in new acquisitions, taking advantage of over a 250 basis points spread in the cap rates between our buys and sells.

The transaction activity during the first six months of the year added 2.5 million square feet of commercial real estate space and 4,500 apartment units to our global platform.

As of June 30, 2015, our global investment portfolio consists of approximately 40 million square feet of real estate, including over 25,000 apartment units and over 300 office retail and industrial properties totaling approximately 16.8 million square feet.

Additionally, we have interest in loans of over $1 billion in unpaid principal balances, along with five hotel properties and over 4,000 acres of land on which we are currently seeking entitlements or under value-add initiatives.

Let me now highlight the major transactions in the quarter. On the buy side, we acquired a 61% equity interest in Vintage Housing Holdings in Q2 for $79 million. Vintage owns interests in approximately 5,500 multifamily units on the West Coast, and will serve as a growth vehicle for us as we continue to build out our multifamily business. Our purchase price on the Vintage investment equated to a 7% cap rate in-place income. Additionally, we assumed great financing on the portfolio with an average interest rate of approximately 3%, and a weighted average maturity of 15 years.

On the sell side, as we previously announced, we sold a 41% stake in our 2,400-unit Japanese apartment portfolio in the second quarter of 2015. Over the life of the investment, we realized a profit of $73 million, which represented a 70% return on our equity over a 5-year period. This is the second time we have had great success in Japan. The first time, we took our asset management business public in 2002 after building that business over the previous decade.

We're also pleased that we were able to keep our Tokyo-based team in place as we have entered into a 3-year contract to manage the portfolio for the buyer. Additionally, we have maintained a 5% equity participation in the new equity that owns the portfolio.

Subsequent to quarter end, we've announced an additional $400 million of acquisitions, including a portfolio in the UK office market, which was acquired by KWE, and a 612-unit apartment community in Sacramento acquired by KW and our partners.

The UK portfolio is in close proximity to London, and was purchased for $332 million at an 8.0% cap rate, and includes such high-quality tenants as British Telecom, Avaya, the UK government, and Pearson PLC. This portfolio is currently 99% occupied with a weighted average lease term of 5 years. The portfolio has substantial near-term upside opportunities driven by rent reviews and lease renegotiations.

The 612-unit apartment community was acquired off market for $100 million and sits on a 39-acre site in an affluent submarket near downtown Sacramento. We have a $7 million value-add program that will be implemented over the next two years at the Sacramento apartment complex.

On to the financing side of the business. We were extremely active in the financing markets for both the quarter and the first half, during which we completed over $1.5 billion of financings. Our financing strategy for both our properties and our corporate balance sheet is generally to go long term with fixed rates. We've been following this strategy for the past several years to take advantage of this historically low interest rate environment, and this year has been no exception.

So far in 2015, we've completed $1.2 billion in new financings at an average rate of 3.2% and an average duration of 6.5 years. 79% of this new financing is fixed rate.

In June, KWE completed its inaugural unsecured bond offering, selling GBP300 million, or $472 million of debt, at an effective interest rate of 3.35% fixed for 7 years.

We are extremely pleased that within 15 months of its IPO, KWE was able to achieve a BBB investment-grade credit rating from S&P, and access the investment-grade unsecured bond market.

This morning, KWE announced its half yearly results. Some of the highlights include a 25% increase in the dividend to an annual 40p per share, or $0.62 per share. And a 9.1% increase in NAV, driven by GBP120 million valuation uplift on the portfolio.

Additionally, the run rate annual NOI on KWE's portfolio today stands at approximately GBP150 million, or $235 million, with substantial upside potential driven by development, refurbishment, and regearing of existing leases. These outstanding results have been achieved in less than 18 months.

KW's investment in KWE has a current market value of $415 million against a book value of $340 million, and represents our largest single investment.

With today's announced dividend increase to an annualized dividend of 40p per share, KW itself is due to receive $14 million of dividends per year. On top of the dividends, KW also receives an asset management fee of approximately $25 million per year, as well as having accrued an $8.6 million performance fee for the first half of the year based on the growth in NAV per share. Assuming no increase in the performance in the second half, KW's total dividend and fees related to KWE are approximately $48 million on an annualized basis.

On the refinancing side, we paid off $315 million of debt, only 115 of which was at a fixed rates, with an average maturity of 5 years and a rate of 4%. We did this with refinancings of $415 million of which 92% is fixed with an average maturity of 10 years and at a rate of 3.1%.

So, together with our partners, we were able to pull out and reinvest $100 million of equity from these refinances, while basically maintaining the same interest payments, given the lower borrowing rates on the new debt.

We have been able to execute our refinancing strategy in the US, as well as in Europe, where rates are currently 100 to 150 basis points less than US rates. We have completed these refinancings while being mindful of our overall leverage at the portfolio level. At the investment level, we are running approximately 50% debt to depreciated costs.

On all our properties financings, we were focused on limiting the recourse from the properties back to the parent company. With that being said, we have over $5.5 billion of investment-level debt as of June 30, of which less than 1% -- 1%, is recoursed to Kennedy-Wilson.

Across all of our debt financing, we have an average interest rate of 4.3%, an average maturity of 7 years, and 84% of our debt is protected against rising interest rates.

Shifting gears now, let's now discuss improving property operations of our portfolio. We have added substantial recurring income to the Company over the past five years, not only from over $16 billion in acquisitions, and the growth of our investment management and services business, but also importantly by growing the income on our existing portfolio through active asset management and value-add initiatives.

Our multifamily business continues to experience robust quarterly growth. For the quarter, across 15,810 same property units, our multifamily revenues were up 8.3% with NOI up 10.7% from the same quarter last year on flat occupancy of 95%. With this quarter's results, we have now achieved 8 consecutive quarters of 8% or better same property NOI growth in our multifamily platform.

The Western US led the charge with revenues up 9.5% and NOI up 12.7% from the same period last year. Year to date, across 15,136 same store units, revenues were up 8% with NOI up 10.5% versus the first six months of 2014.

85% of our multifamily units are located in the Western US in markets that we believe continue to have great fundamentals, with the majority of the units in the Seattle area and the San Francisco Bay area.

A good example of one of our Bay Area properties is a property by the name of Summer House, which is currently 94% owned by KW. The investment consists of 615 units located in Alameda, just outside San Francisco.

Since 2010, KW has invested $3.1 million of value-add capital, which includes building a new 3,500-square feet club house and unit refurbishments. During that period, the property revenue has grown 53%, and the NOI has grown 80% to $10 million on annualized basis.

For the second quarter of 2015 alone, A Summer House has revenue growth of 15% and NOI growth of 20% compared to the same quarter in 2014.

Moving on to the commercial side of our business for the quarter, same store commercial revenues on approximately 10 million square feet of real estate grew 1.1%, leading to NOI growth of approximately 25. This increase was driven by occupancy growing from 87% to 91% over the past 12 months.

For the first six months, on 7.3 million square feet of same property real estate, revenues increased 2.1% with NOI higher by approximately 3%, driven by a 2% increase in occupancy.

It's worth noting that occupancy in the Western US commercial portfolio was at 83% at the end of the quarter, with the majority of the vacancy housed in a handful of office buildings located in Southern California that we acquired over the past few years. These buildings were either vacant or had very low tenancies at the time of acquisition.

As of June 30, there was approximately 800,000 square feet of vacancy within the office portfolio in Southern California. Roughly 50% of the vacancy is now spoken for through a combination of executed leases, signed LOIs, or completed and planned asset management sales -- asset sales.

Given the prime locations of a number of these assets, including Beverly Hills, Marina Delray, Pasadena, and North Hollywood, we currently expect the rental rates on this space to be well in excess of our average rates, and therefore will have a substantial impact on our ongoing operations.

In addition, we are focused on growing the recurring income of our lower yielding investments over the short to medium term through a variety of value-add, redevelopment, and entitlement initiatives within our existing portfolio. Some of these initiatives are complete, but most of them are just getting underway. We have an in-house team in both the US and Europe that is highly capable of working through complex entitlement and construction processes for these various properties.

We are working on significant value-add projects at over 20 properties, most of which will have meaningful impacts on the income streams. But, these initiatives are on excess land that we purchased of little or no cost basis.

We are currently entitling or building over 1 million square feet of office, and over 4,000 apartment and residential units globally, including over 400 that are currently under construction on land with little or no cost basis.

During the quarter, KW invested $27 million in new properties undergoing significant value-add initiatives. A good example of this is our Capitol Towers project in Sacramento, which we acquired in May 2012. Capitol Towers has 409 units and sits on 10 acres in downtown Sacramento. Downtown Sacramento is undergoing tremendous revitalization right now, including the new arena for the Sacramento Kings basketball team.

The current income on the property is approximately $4.6 million per year against a cost basis of $66 million, which equates to a cap rate of 7%. But, in July, the Sacramento City Council approved entitlements on our property for master plan redevelopment. The plan consists of a multi-phase development including three high-rise residential towers with the potential for a hotel and three mid-rise residential buildings, ground-floor live/work units, and up to approximately 75,000 square feet of commercial space, together with substantial site amenities. The project also retains the existing Capitol Towers high-rise residential tower.

In total, the project will include up to 1,470 residential units, which is a 1,061-unit increase over our current unit count. By securing these entitlements, we have added substantial value to this property. And this is just one of many examples within our portfolio.

In Europe, at Clancy Quay in Dublin, Ireland, in which KW also owns a 50% ownership stake, we've recently received planning permission. Have just begun building an additional 164 units at this project, which currently has 423 completed apartment units.

The 164 units are part of an adaptive reuse of old barracks buildings. At the time of acquisition, we assigned minimal basis to this component of the investment. Upon completion, we expect the revenue and NOI of the overall project to increase significantly.

In addition, we are entitling a third phase of this project, which would bring the total unit count to approximately 800 units from the 423 that we originally acquired in 2013.

Finally, let's discuss our current liquidity, capital position, and outlook. Even after completing $2 billion in acquisitions this year, we find ourselves in the best financial position in our history with over $1.6 billion of liquidity between KW and our consolidated subsidiaries, including nearly $1 billion of cash and $650 million of unused lines of credit.

As of today, between KW and KWE, we have approximately $2 billion of unencumbered assets, including our stock ownership position in KWE, which as I mentioned in my previous comment today has a market value of $415 million.

In addition to our existing liquidity, we expect to generate significant cash for the combined companies for the remainder of the year through a combination of cash flow and planned asset sales.

We believe that it is prudent to maintain substantial liquidity and flexibility in this volatile world in order to take advantage of any opportunities that may present themselves. We have seen interest rate, currency and stock market fluctuations, along with geopolitical events as witnessed recently in China and Greece. We mitigate these risks through fixing our interest rates, hedging our currency risk, and growing the recurring income streams of our assets.

However, we view this volatility as any potential opportunity which may come along, which is why we maintain the high levels of liquidity so that we have the ability to take advantage of any market inefficiencies.

While we remain very careful in our investment process in this very competitive market, we continue to find off market opportunities to invest in deals that are sourced for our global network, which we have built over the past 26 years.

Given the scale we were at, both from a balance sheet perspective and with our great team of people, and given our strong track record of producing great returns for ourselves and our partners, we are seeing many sizeable opportunities today that would not have been possible even a few years ago.

Over the past several quarters, we have increased the pace of dispositions while remaining focused on value creation opportunities for the Company. We are very, very pleased with the progress we have made not only this quarter, but over the past 5.5 years as a public company.

With all of this information, it still leads us to the conclusion that really our best days are yet to come. With that, I'd like to open it up to any questions you might have.

(Operator Instructions). Vincent Chao, Deutsche Bank.

Just want to touch base on the disposition activity here. I think about $1 billion down already so far this year. And I thought last quarter you talked about trying to do about $1 billion for the full year. It sounds like there's additional planned ahead. Just curious, just order of magnitude how much more in dispositions should we expect here in the back half?

I'm going to give you a bit of a range here. But I would guess, Vincent, in the second half of the year that you're going to see somewhere between $300 million and $500 million of additional dispositions.

Okay. And that's sounds like it's largely going to come from the office portfolio there in Southern California.

It's going to come from the office portfolio. We have a few multifamily properties where we have partners in that we will be disposing of in the second half of the year. And there's a few planned dispositions in our KWE portfolio in the second half of the year.

Okay. I guess as you're just thinking about the commercial portfolio in Southern California, so it sounded like a lot of the vacancy is now addressed. I guess for those that are not displayed for sale, I think now that they're stabilized, is the longer-term plan here to sell those eventually as well, just given where maybe cap rates have gone, and just the fact that you have sort of stabilized some of those assets.

I've said on earlier calls that we have a few core office properties that I think you will see us keep long term. But I've said generally there is a very big difference between the office leasing market in Europe and the office leasing market here in the United States in general. The lease terms in Europe tend to be much longer. For example, the lease the Mary just did on our Baggot Street building in Dublin has a lease term of 25 years.

Generally speaking, here in the United States, the lease terms tend to be between 5 to 7 to 10 years, which means that on a regular basis, you're re-improving capital of these office buildings. And so that makes the office business here in the United States more challenging than it is in Europe.

And so from time to time, and especially in this cap rate environment, we're taking advantage of any opportunities to sell where we think the buildings have stabilized. But as I said earlier, there's a core group of maybe 5 or 6 office buildings here in Southern California that you'll see us keep long term.

Okay, thanks for that. And just maybe thinking about some of the global uncertainty that you mentioned. Just curious how that's impacted sort of the financing environment in Europe. Obviously you got the unsecured debt offering done probably at a pretty good time. Just curious how those markets look today, and also if there's been any impact on sort of the investment opportunities that you're seeing. Have you seen some of the disruption there create more opportunities than you've been seeing of late?

Mary, you want to comment on that?

Sure. So you mentioned in terms of the debt market and --

Yes, some of the volatility you were seeing there.

Yes. So, I think you're alluded to we're really pleased with the sort of pricing the bond when we did and closing it when we did. I think the market was open in Europe for just a couple of days, and we got it done there. So we got pretty lucky there.

In terms of our acquisitions, and just the volatility in Europe, clearly the volatility is we think holding the euro debt, the euro secured debt market down quite a lot. So that's helpful on the secured side.

And in terms of acquisitions, there's still a lot of distress here. Nama still have $12 billion on their balance sheet. Sareb has $44 billion. And in Italy, there have been in the first half, $1.5 billion sales have traded, which is double the amount traded for the entire year last year. Spain is picking up. A lot of transactions there.

So we're seeing a ton of opportunities. And we're just pricing in whatever risk it is. And I think you know that we have the ability to invest across asset classes, jurisdictions, and the capital stack. So that sort of allows us to maintain the pricing discipline and get good deals on the way in.

Okay. Thanks.

I think, Vincent, just one the [marries], if you look at the interest rate differentials between the United States, today, roughly the 10-year in the United States is at 2.25, 2.30, something like that. But the 10-year in Ireland is 100 basis points less than that. And so -- and that's pretty much true across Europe in the what I'll call the more stable economies -- Spain, United Kingdom.

And so as I said earlier in my presentation, there's still about 100, 150 basis points spread with rates being that much lower in the European market than here in the United States.

And also I think obviously the big change in the European market, when we first went to Europe in 2011, and we were really kind of the first to get there on the US institutional side, there was no debt market at all. All the early acquisitions that we did in Europe basically were all equity. But obviously today, there's an extremely liquid property financing and debt market in Europe. But, as Mary said, there are still plenty of opportunities to invest in the markets that we like in Europe.

Okay, thank you. And just maybe one last one from me. So you've got some dispositions coming down in the back half. Obviously you've got a fair amount of liquidity already on the balance sheet. Debt I think it pretty close to your target at about 50%. I'm just curious how you think equity at the KW level plays into future liquidity decisions. Or is it just going to be mostly focus on dispositions, given that the stock, really, it's been somewhat range-bound, I guess, despite you guys continuing to put up some pretty good numbers, we think, and continuing to make accretive investments here. Just curious how you're thinking about the equity component.

I mean we're very focused on generating cash internally. And doing our investing activity off of the internally generated cash. And so we don't have any plans at the present time to issue any equity. And we have a, as you all know, we have a big ownership interest in the Company. We think that the KW stock is a very solid value proposition today. And so we're very, very focused on generating cash internally as opposed to raising capital externally.

Okay. Thanks a lot, guys.

Mitch Germain, JMP Securities.

Hey, I just have a question on the asset sales. Are they going to be granular, or are you thinking about possibly doing some portfolio?

They're mostly individual asset sales, Mitch. We have about -- I'm doing this from memory math -- but we have probably, oh, I'd say 10 individual asset sales that we have planned right now that are currently underway that are in that. To re-reference that $300 million to $500 million are inside of those numbers that I mentioned to you earlier. But there are no portfolios that we're selling.

Great. And then I appreciate the extra disclosures this quarter, particularly on the development. And I'm just kind of curious, Bill, in your call with regards to how you look to manage development, making sure that you're not overexposed, particularly doing something a speculative way. So maybe just kind of your thoughts surrounding that piece, I'd appreciate it.

Well, I think there's two things, really, to think about there. First of all is your team. And so we have both here in the United States and in Europe, we have an extremely experienced team of people that are involved in both entitlement and construction. If you added up the amount of years that the people that we have in those businesses, it's in the hundreds of years that have been doing this. So this is not any kind of maiden voyage.

But the point I really want to make and reemphasize is that just like in the case of that Sacramento property, or in the case of Clancy, we bought properties that already had an above-market yield from the existing income that was being generated from the buildings that were already on the property. It just happened that we ended up with excess land, either on the site or next to the site, that we were able to buy and allocated almost zero cost basis to.

So, a really good example that I didn't mention, Mary, is really the State Street site in Dublin, which is arguably one of the finest locations in all of Dublin. But when we bought that property, it came with roughly 175,000 square feet building that's leased for 15 years to State Street. Next to it, in that acquisition, came roughly 3+ acres. And then there was an additional couple acres next to the site that we were able to combine into a joint venture with an Irish institution. So now we have 5 acres that we're entitling right now for roughly 700,000 square feet of multifamily residential apartment units and office.

Once we get that entitled for that 700,000 square feet on land that has virtually no cost basis, we make a decision every time. That land is extremely valuable today. But, then we make a decision -- does it make more sense to de-risk, put it in a joint venture, sell it, all those options that you have available to yourself. And so each circumstance is evaluated individually.

So, the big value creator is getting the entitlements done. Right away you've added significant value that isn't on your balance sheet as soon as you get entitled. But believe me, we're very, very mindful of what I call development risk. We would never go into a situation where we just bought a piece of land to build a development on it. It just wouldn't be the case. It would have to have some story attached to it.

Great. I appreciate your thoughts. Good quarter.

Thank you.

Craig Bibb, CJS Securities.

Hi, guys. Sorry, I had to hop on late. So if you already covered this, I apologize. Could you -- it looks like, broadly speaking, you see an opportunity to recycle capital from Japan to Europe. Are there other sectors that you kind of see other capital recycling broad opportunities?

Well, I think the two places that we've recycled capital to are Europe and to our multifamily business. And so if you look back over the last I would say 5 or 6 years, we have more than doubled our investment in the multifamily business. And of course, as you all know, our business in Europe didn't exist in 2011. We made our first investment in Europe in the second quarter of 2011. And so the focus of where the capital got recycled was really into our multifamily business in Europe.

And remember, too, with bringing that capital back from Japan, we almost immediately bought the Vintage portfolio. And not that it was part of our strategy, but it also gave us more apartment units in the Seattle market, which has more Fortune 500 companies headquartered there than in Los Angeles. And, it took away any currency risk that we might have the yen to the dollar. That wasn't the reason that we did it, but it had the effect of letting us reinvest in a very growing market with growing NOI and growing revenue, away from a market where there was some currency risk, but over the last few years has had some modest rental growth in rates and NOI, but not like it has in the Western United States and in Europe.

Okay. And can you -- what is kind of the outlook for NOI growth? We've had 8 quarter in a row double-digit NOI growth in multifamily. What's the outlook? Are we close to maxing out, or give us a kind of a broad stroke on the outlook there.

Well, I'll let Matt answer part of it. I don't know that we're close to maxing out, because you have to really think about the kind of properties that we buy. And so we buy generally very well-located assets, but ones that have a value-add component to them. And so Summer House was a good example where you saw -- you've seen a tremendous growth in the NOI of that property over the years. We own a property here in Los Angeles called [Chadwood], which we own 50/50, with a large New York-based family. And the NOI growth in that property has been almost similar to Summer House, but we've spent in the last -- it's extremely good location, but we've spent almost $8 million in capital on that property in the last couple years.

And so it's not any great revelation, but what we've learned in our multifamily business is that if you can amenitize these properties with fitness centers and business centers and all of those sorts of things, and you can refurbish these units that in some cases were 20 years old, that people will pay a premium to be in your properties. And so as opposed to like a brand new building, basically we're fixing up 20 and 25-year old properties here in the US.

And Craig, this is Matt. Just to add what Bill's saying, if you look at our revenue and NOI growth on the multifamily portfolio, particularly in the Western US over the past several years, we've outperformed the overall market, and we're doing that by, as Bill said, buying things that we can add value to. So even -- we're seeing the markets stay very strong, but our goal is to always outperform the market by buying things right and adding value.

Okay. And last one, what's the outlook for occupancy in your commercial sector?

Well, I would say that the core assets that I mentioned to you that are here in Southern California that we plan to keep long term, those by the end of the year will all be in the 95% occupancy range. And most of the others will be either in the high 80s or low 90s. And we have a few that are slated for sale here in the second half of the year.

But the core ones that we plan to keep -- and there's only five; they're sizeable, but there's five of them -- those buildings are always going to run in the 95% occupancy range.

Great, okay. Well, thank you.

David Ridley-Lane, Bank of America Merrill Lynch.

Sure. So in the second quarter, you gained control of another three assets. Can you give the rough amount of rental revenue that will be in the run rate now in the P&L?

Let's see.

We're not going to give the revenue, but the NOI is about $25 million from those assets. And we did have a minor ownership in those, so we're probably adding about $20 million from those specific assets on an NOI basis.

Got it. Okay. And then on the value-added development initiatives, $85 million this quarter. Definitely appreciate the disclosure around future plans in the release. Should we be expecting the spending to continue to ramp, or is this kind of a decent run rate for the next couple of quarters that you're kind of expecting?

I think it's -- David, this is Matt. I think it depends, as Bill was mentioning, as we get some of these projects entitled, we're going to make decisions on whether to proceed or whether to enter into a JV or to sell. So I think it's going to be very specific asset by asset and depending on how we finance it.

But I think we had a number there of $2 billion of total costs to complete. And there's no chance that's coming out of our pocket, all of that. So it's going to really be dependent on each project individually.

I would guess that over the next 12 months that -- again, I'm giving you a range. The capital that would come out of KW would be in the $50 million to $75 million range.

Got it. That's very helpful. And then I know this will be a tough one to answer, but sort of within the 8% same property revenue growth, is that mostly the value-added activities helping to drive rental rates above market? Is it kind of 50/50 market rents rising versus value-add? I know that's a difficult question to ask, but I thought I'd try.

No, sure. We study that very carefully. It's about two thirds market and about one third value-add over the past couple years in the Western US. But there's obviously been some good rental growth in the markets, but we've added on top of that with the value-adds.

I think to Mary, as you were talking on your conference call today, I think the property you bought in Ilford is a good example of kind of how you've used all your disciplines that will clearly create rental growth not only out of the market growth, but also what you're going to do value-add wise. So I think that's another good example to talk about.

Sure. So that's -- Bill's referring to what we call Pioneer Point. And we bought a loan from a German bank. We paid GBP68.5 million. The unpaid principal balance on that loan was GBP149 million. And this German bank had basically wrestled control of these two high-rise new-built towers in London's zone four in an area called Ilford. And the developer was into those towers for about 130 million. So we bought it at a serious discount.

The bank had let one of the towers, but then the other tower they kept vacant purposely. And then there's also a podium commercial space that's been left raw. And so I was just actually on site last week with a couple of our teammates, and we're looking at the podium because we're going to basically take the US model -- which we've done many times before to our assets in Dublin, and a little bit as well in our resi project just outside of Manchester -- and we're going to put an amenity package in, just like Matt and Bill have been talking about on the call. And then we're going to go ahead and renovate the one tower in terms of the furnishings, et cetera, finish it, and then lease it. So basically it's going to go from our asset via loan strategy to our value-add, and then that asset will become a very core institutional, fully-led PRS, as they call it here in Europe, asset, which is a highly sought after product type.

And one thing I should have mentioned, too, that I think will be helpful to all investors, I know we presented this to our Board yesterday, monthly and quarterly now, on any of these I would call major value-add projects, we're actually using the drone to photograph all of these things. we're going to be putting on our website here, probably will be by the end of next week, pictorial drone shot, for example, of what we're doing at Clancy Quay in Dublin. And you'll be able to visually look at these high-rise buildings with 423 units that we already have, which -- and just by way of reference to that, roughly, in euros, the total cost that the bank and the developers had in that site was EUR280 million. We bought that, Mary, for around EUR85 million? So, in the drone site you'll see at the end of next week, you'll be able to see the high-rise buildings which were all finished, but we completely amenitized that property with fitness centers, business centers, unheard of before in Ireland.

So we're running almost full occupancy now in those high-rise towers. And then you'll see behind those high-rise towers the vacant land where these barracks, so-called barracks buildings sit.

So periodically now, we're going to be upgrading this site, the website, with these drone photographs that you'll be able to see where we're doing the work.

Picture's always worth a thousand words, so that sounds very cool. Thank you very much.

Vance Edelson, Morgan Stanley.

Beyond your own expertise in monetizing and maximizing the value of your holdings, increasing occupancy and raising rents and so forth, what are your thoughts on the fundamental momentum of your markets right now? Would you say you're getting a strong tailwind from an improving economy in any of your regions? Or do you feel like you're really doing the heavy lifting globally because economic strength leaves a lot to be desired?

Well look, it's obviously a combination of both. We, even though we are not executing this way, we have a belief that you're going to see interest -- even though interest rates may increase, and even though we're fixing the great proportion of our debt, we think we're in for a much longer period of very moderate interest rates.

So, having said all of that, I think that in the markets that we're in -- and we always like to be in these very high barrier-to-entry markets -- Seattle, Southern California, the East Bay, Dublin, the United Kingdom -- where it's very difficult not only to find additional land, but to find -- to get things entitled. That's a real skill set to be able to get things entitled. And so you're going to see I think natural growth in those markets that we're in.

We never have, never will -- and I'm not critiquing what was going on in the Midwest, for example, when all the fracking and -- you can get into the apartment business there and the rents were going like crazy, and now looks what's happened because oil prices have declined, the properties are basically gone down a lot in value. So we try to stay in these very high barrier-to-entry markets.

But, again, having said all of that, we have a full team of people across every product type, whether that's apartments, office, retail, that are extremely -- have great expertise in value-add initiatives.

And then I think two, as you all know, we -- Mary and I have been together here for almost 25 years at KW. We work very hard to keep the same team of people together for very long periods of time so that when we go about executing these value-add strategies, there is no real mystery to what has to be done.

So, we're careful about spending money. We're in high barrier-to-entry markets. But we believe that the markets that we're in are going to continue to have growth opportunities.

Okay. Thanks for that. And then you got into this some, but could you talk a little more about the embedded growth potential for the commercial portfolio? You mentioned the portion of vacancy that's already spoken for. And I might have missed it, but is that just referring to what's already leased, and you just have some free rent burn off to get through? Or is there leasing pipeline ahead that give you confidence that the leased rate is going to climb? And whatever the combination, are you seeing that as early as yearend this embedded opportunity is going to be pretty much fully realized?

I don't know by year end, but I think that we'll be a long way down the road to creating that income stream. But I think you'll see those kind of improvements really show up in 2016. And --

There's some of the -- the 800,000 feet that Bill was mentioning in Southern California, where roughly half of that's spoken for, some of those are major leases that we've entered into, and it can take six to nine months for our tenants to take occupancy. So, there's definitely a lag between the leasing and the revenue. Obviously you add a lot of value by getting a lease done.

Right. But I think, just to kind of frame it in some context, if you think about KWE, in February of 2014, we started with cash. That's all that was in that business. Today, Mary and her team have created a recurring NOI stream of almost $240 million. Having said all of that, there's a lot -- in both the US and here, there's many opportunities now to kind of regear existing leases. Matt told you about the roughly $20 million of net NOI income that we've added just in the last 30 days here in the US with these three acquisitions and consolidations. The so-called FEO portfolio in KWE that was acquired in July, in dollar terms, that has an NOI of almost $25 million a year with, as I said, very, very high quality credit tenants. And so what is somewhat masked in these first six months' numbers is that we've added, really just in the last 60 days, both the KWE and the three things that I mentioned here in the United States, we've added a tremendous amount of recurring income.

Okay, that's very helpful. I'll leave it there. Thanks, guys.

David Gold, Sidoti.

Just a quick one, Bill. You spent some good time speaking about second half thoughts on dispositions. Just curious if you can give similar type color on second half thoughts on the acquisition side, particularly geographically speaking. An update, if you can, also on Spain and any other geographies you might be looking to establish a foothold near term. Thanks.

Think about it in terms of really kind of the last 5.5 years. We've now, we're closing in on $17 billion of total acquisitions during that period of time at cost. And except for the corporate acquisitions in some of the big private equity firms, and I would guess had been one of the bigger acquirers globally during that period of time.

As I said, we had really a record first six months in terms of both the acquisitions and the dispositions. And last year, our total acquisitions totaled slightly over $3 billion. As we sit here with the July acquisitions, we're almost at $2.5 billion for the first seven months. And so I'd be surprised if we didn't exceed last year's total.

So it's a balance right now of continuing to find great opportunities, and also selling things in this very attractive cap rate environment. But I think for the year, we'll certainly be ahead of where we were at last year.

Got you. And then just following up on where we are in Spain and any other geographies you're starting to look at for establishing foothold.

Mary, you want to talk about Spain and Italy?

Sure. Yes, that stuff sounds good. I was just in actually in Madrid in Spain last week. So Spain, we're feeling that it's really in recovery. It's just posted its strongest quarterly growth in the last 8 years. And we're seeing that Madrid and Barcelona are recovering at a pretty fast rate. And we are pursuing investment opportunities in these two cities, as well as, I would say, strategic micro locations.

And specifically we have done three deals thus far in Spain. We bought a property that was sort of a complex situation. It was a retail asset in Madrid, really in like the sort of Times Square or Piccadilly Circus, if you will, of Madrid --sort of the best retail area there -- that is right across the square from the largest Apple flagship store. And when I was there last week, it was just, I was going to say 34 degrees because now I talk in Celsius, but it was roughly 90+ degrees, and it was just teeming with people. So it's a great asset for us. We're going to reposition that and turn it into sort of a retail flagship store.

And then we've also bought a couple of assets also in a similar location, great location in Madrid, that we're going to be converting to resi. And we've been seeing residential prices in our first asset we bought, an asset called [FT5], where sales prices have increased already by 8% in the 8 months that we owned it.

So, we sort of like the resi space, we like the retail space. Consumer confidence is back in Spain. We're seeing that translate to higher retail sales. So Spain feels good. And we definitely have a nice pipeline in Spain.

And then in Italy, we're looking at something that's pretty interesting in the most part in really all of the northern cities in Italy, direct real estate. And really, I think in Italy, we're seeing the highest transaction volume that we've seen in many, many years in Italy. So a lot of capital there. There's good liquidity in Italy.

And also, real estate cap rates, yields -- there's the farthest spread between yields and government bonds that's really been seen in decades in Italy. So if you look at sort of a 7-year Italian bond, it's like 1.4%, 1.5%. So for a piece of real estate with a similar tenure of lease with sort of good, solid income, you're going to be kind of 500 to 550 basis points ahead of that. So, we like that spread, and we like, for specific real estate assets, we're looking at some stuff in Italy right now.

Perfect. That's helpful. Thank you both.

You're welcome.

Eric Miller, Circle Road Advisors.

Yes, congratulations, guys, on continuing outstanding execution. I know you've delved into the multifamily market, but just one last question. Bill, you guys have been involved in that for a long time. I assume you collect a lot of demographic info on your renters and stuff. Do you get from that anything that makes you think not only is there a cyclical component to the strong multifamily business, but there may be really just some secular things going on in that market?

Yes, Eric, it's a very, very going point. I think it's -- I can tell you think is true in the United Kingdom, it's true in Ireland, and it's definitely true here in the Western United States that there has been a major shift away from home ownership to rental. And you've seen this great growth in what they call the millennial, the 25 to 35 year olds.

And particularly here in the Western US, the cost of housing is very expensive. You have people earning good incomes, but with the new credit standards generally, and the down payments that people are required to come up with, it makes it difficult to buy. And so you've seen a decline in home ownership and a very much an increase in the rental, use of the rental apartment market as a -- for your housing.

And so I believe that over the next 10 years, you're just going to see that increase. And so you've got those increases happening in terms of the number of people that want to rent in markets where there's very high barriers to entry where it's almost impossible to get stuff entitled, or, in some cases, to find land. So, it has the obvious effect of putting pressure on rental rates, which is why I believe long term, for that reason, the apartment rental business is going to be a fantastic business in all the markets that we're in. And the second part of it is is that the capital commitments, once you've done your initial upgrades, the capital commitments that you have to commit to, even refurbishments, and any common area work, are miniscule compared to what you have to commit to, say, office building refurbishments.

And so the apartment rental business is, particularly here in the US, in the markets that we're in, is a very, very attractive long-term business that's going to continue to show growth over the next 10 to 15 years.

Okay, great. Thanks.

Thank you. I will now turn the call back over to Bill McMorrow.

Okay. Again, thanks, everybody, for joining the call. We appreciate your support and the questions. And as I said, not only did we have a great first half of the year, but having been here for 26 years, I can tell you that I really feel like with the base, the capital, the liquidity and everything that we've been able to assemble here, that the future does look very bright for both our companies. So thanks very much.

Thank you. And thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.