Kilroy Realty Corporation

Hello, and welcome to the Kilroy Realty Corporation Q1 2020 Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touchtone phone. To withdraw your question, please press star then two. Please note, today's event is being recorded. I now would like to turn the conference over to your host today, Tyler Rose. Mr. Rose, please go ahead.

Good morning, everyone. Thank you for joining us. On the call with me today are John Kilroy and several other senior members of our management team who will be 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 eight days, both by phone and over the Internet. Our earnings release and supplemental package have been filed on a Form 8K with the SEC, and both are also available on our website. John will start the call with the actions we have taken to protect our employees, support our tenants, and sustain our organization through this unprecedented health pandemic. He will then review the impact COVID-19 has had on our business, markets, and development plans, and we'll wrap up with our priorities as we move through the remainder of the year. I will provide brief first quarter financial highlights, give an update on rent collections, and then review our current financial position. Then we'll be happy to take your questions. We're all calling in remotely, so bear with us if there are any delays in our responses. John?

Thanks, Tyler, and hello, everyone. Thank you for dialing in today. We appreciate that many of you are juggling a lot of personal and professional challenges right now. This is the first time I can honestly say that I've taken the load out of the washing machine five minutes minutes before a conference call. All of us at the company here hope that you and your loved ones are safe and healthy. And importantly, we want to acknowledge the men and women who are servicing the most critical elements of our society during this time. We're so grateful to everybody, medical professionals, researchers, grocers, truckers, all the rest. They're helping us stay well in shelter in place. Here at KRC, we have been in daily communication with our employees, our tenants, and our construction team since the West Coast began shutting down non-essential business activity roughly six weeks ago. Our corporate team, largely working from home, has adjusted its operating protocols to ensure that everyone, from our engineers to our board of directors, is getting the guidance and support they need to make good decisions. All of our operating properties are open and staffed with on-site property managers and security and all are following CDC recommendations for virus mitigation, including frequent high-touchpoint cleaning and daily disinfecting. To start, let me review where we stand financially and operationally. For those of you who follow our company closely, you know that we operate from a core set of business principles that emphasize financial strength, top-quality markets and assets, and strong credit tenets. We have basically built a moat around this company and came into this crisis in a strong position. We have significant liquidity, limited expirations, a young portfolio, access to multiple sources of capital, no near-term debt maturities, almost no secured debt, and a well-capitalized tenant base. Let me review this in more detail. Our balance sheet is solid. We have $1.4 billion of immediately liquid assets. This includes $1 billion of cash from the $725 million drawdown in mid-March of all our equity forward sales and $350 million from the recent issuance of private placement debt. We also have $370 million available in debt capacity under our credit facility. Further adding to our balance sheet strength, we don't have any debt maturities until 2023, excluding our credit facility, which matures in the third quarter of 2022. Our stabilized portfolio was in excellent shape heading into this crisis and remained at 97 percent leased at the end of March. We have only 5 percent of our leases rolling annually over the next three years, and our average lease term is approximately seven years. Having said that, we are seeing some stress in primarily non-office revenue streams, which I'll discuss in a moment. Our 2 billion of projects under construction, including the three projects now in the tenant improvement phase, have been effectively de-risked and fully funded. The Office of Life Science component of these projects is 90 percent leased to large technology, media, and life science companies. The projects have a total remaining construction spend of approximately $2,725 million that is fully funded with the liquidity I discussed above. The properties are located in the submarkets of Seattle, South San Francisco, Los Angeles, and San Diego, and all remain under construction. Our relationship with large, stable, innovation-focused customers are proving to be an advantage. Our pro forma top 15 tenants account for approximately 50% of our annual revenues. They are, for the most part, publicly traded and investment-grade rated. These leases have an average term of longer than 10 years with average annual rent escalators of 3%. Some of our top tenants are even in the business of making stay-at-home life a little bit easier, including DoorDash, Apple, Amazon, and Netflix. While we are in solid shape financially and operationally, the most immediate impact to our business is largely in the non-office components of our company, including retail, co-working, transient parking, and residential. While none of them by themselves is that material, the impact from some may stay with us longer than others. Our exposure to retail is approximately 3 percent of our revenues, and most of that is concentrated in a handful of properties, most notably One Paseo in San Diego. As of now, we have established a program with approximately 90 percent of our retail tenants that provides them with two months of rent relief and gets added on to an extended term. Our co-working exposure is approximately 1.8 percent of our revenues, with most of it in one very high-quality property in Hollywood. Tyler will discuss this component further in his remarks. We also have transient parking that makes up approximately 2% of our revenues. We estimate that this revenue stream, which includes daily, short-term, and event parking, will be impacted while the stay-at-home orders are in place, but will ramp back up as people come back to work. Lastly, leasing activity has quieted in our residential portfolio, which makes up approximately 2% of our revenues. Before the crisis hit, Columbia Square was 95% occupied. The first phase of Juan Paseo was already 70% leased, and the second phase reached over 15% leased just a few weeks after opening. We have implemented a virtual tour and leasing program, and we have made some success, but until the stay-at-home orders are lifted, we expect the pace of leasing and move-ins to be slow. Notwithstanding the stress we're seeing in our non-office components, we're still making some leasing progress throughout the portfolio. Just in the last two weeks, we've signed two leases and are close on a third that total approximately 123,000 square feet. They include a lease with a life science company in San Diego, a lease with a gaming company in Los Angeles, and in Seattle, we are in advanced negotiations with a major technology company. Given the unprecedented challenges we are working through, it is difficult to give a roadmap today for the next six to 12 months. And while we have always endeavored to provide clarity, this is not one of those times where we can. However, here are four key areas in which we will be laser focused as we may move through this crisis. First, we will continue with our conservative approach to balance sheet management. We are focused on maintaining a strong profile with low leverage and diversified access to capital. This includes continuing the effort to complete 150 to 300 million of dispositions, which was the guidance range we had communicated on our last call. Before the crisis began, we were making good progress on two of the dispositions. However, given the current environment where lenders are unable to appraise and buyers unable to tour, we'll have to take a wait and see. approach. Second, we are highly focused on completing our $2 billion of under construction development. We are in the fortunate position of having largely secured construction materials and are now in the tenant improvement phase in several projects. We will continue to stay close to the construction ordinances across the various jurisdictions to ensure our projects are moving ahead safely and as close to on time as possible. Third, our leasing teams are unwavering in their efforts to lease up vacant and expiring space. While new tenant tours are on hold, we continue to see progress with existing tenants for renewals and expansions. We have not seen a material retrading of economic terms across the office and life science transactions and expect those sectors to see continued growth. And as we've previously reported, we only have one expiration over 100,000 square feet this year That's the 130-some-odd thousand square foot lease, our Long Beach property, where we are in discussions to lease a significant portion of that space to a credit tenant. Fourth, we are looking ahead. Well, at this point, demand patterns for real estate sectors are unpredictable. In our discussions with our Office of Life Science customers, it is clear there will be a flight to quality. They will focus on buildings that are sustainable, have modern systems, and that can accommodate the changing protocols that companies are implementing. As you've seen over many years, we have been leaders in the functionality of space. We were one of the first to embrace sustainability, and most recently, we began focusing on fit well and well buildings. All of this, we think, differentiates us from many of our peers, and we are now taking the lead in creating best practices for the future. We have already brought a hygienist on board. We are rethinking how people enter a building and what they touch. We are evaluating how to manage elevator occupancy levels. We are studying ways to improve filtration systems. And we are working on new policies and procedures that emphasize personal space and adhere to social distancing guidelines. A lot more of this to come. To wrap up, I want to make the point that our employees have done a phenomenal job in responding to rapidly changing circumstances. One of the few pleasures of this crisis for me has been to witness how effectively they have adapted on the fly and the level of commitment and concern they have shown for our tenants, our business partners, and one another. That's the picture of where we stand today at KRC. We believe that our organization and our people are well prepared to focus through this crisis. and that our company is well positioned to move ahead. That completes my remarks. Now I'll turn the call over to Tyler. Tyler?

Thanks, John. We reported solid first quarter results that came in above our expectations. They do not, of course, reflect any meaningful impact from the current crisis. FFO was $1 per share in the first quarter, driven by early rent commencement of the exchange, offset by a reduction in revenue of approximately $0.06 per share, primarily related to the cumulative impact of transitioning a co-working tenant and two retail tenants to a cash basis of reporting as a result of the pandemic. Turning to same-store results, cash NOI grew 14.9%, and GAAP NOI was effectively flat in the first quarter. Cash NOI growth was largely driven by higher rental rates, cash commencement of several large leases, as well as a cash lease termination payment that was accrued in 2019. Excluding the payment, cash same-store NOI was up 11.3%. GAAP NOI was impacted by the revenue reversals I just mentioned, Excluding the reversal, same-store gap NOI was up 4.2%. At the end of the quarter, our stabilized portfolio was 93.5% occupied and 97.3% leased. In mid-March, as the severity and wide-ranging impact of the coronavirus became more apparent, we decided to physically settle all of our outstanding equity forwards, adding approximately $725 million of cash to our balance sheet. Further, given the ongoing uncertainty in the capital markets and the potential delay in our dispositions, We accessed the private debt market and raised $350 million in 10-year debt at a rate of 4.27% to further add to our liquidity. We completed the transaction just two days ago. It was oversubscribed and upsized and had a strong list of institutional investors. With these two transactions and availability of $370 million under our revolver, our current liquidity total is $1.4 billion, and our net debt to first quarter annual IDBITDA is 5.6 times. This liquidity allows us to fund our remaining $725 million of development spending and further provides us with sufficient resources to be offensive should opportunities arise. Additionally, we have plenty of room under our bank financial covenants with more than a 45% cushion or approximately $250 million of NOI cushion. As John mentioned, our top 15 tenants make up about 50% of our revenues. In addition, another 25% of our revenues come from publicly traded, sponsored, or investment-grade rated tenants. Now let me give you some color on rent collections for the month of April. Across all property types, excluding the retail restructuring John mentioned, we have collected approximately 96% of our April contractual rent billings. Adjusted for the retail restructurings, we've collected 93% of our buildings, including 96% from office and 88% from residential. Generally, in terms of the pace of payments, there were a few delays, but by mid-month, we received a large majority of the expected buildings. Lastly, we are withdrawing our earnings guidance for 2020 at this time, given the uncertainties generated by the coronavirus and its impact on business activity. While we have identified the primary areas of potential impact on our portfolio from COVID-19 today, there are too many factors that could change our assumptions, including revenue recognition timing and other macro-related factors. Instead of formal guidance, we can offer the following assumptions, based on what we know today, that may be of use in assessing our potential earnings results for the remainder of the year. From a financing perspective, the early drawdown of equity and the debt offering will have a dilutive effect of approximately 17 cents per share on our earnings when compared to our original guidance. We have no plans to complete additional capital raises at this time. However, as our track record has shown, we take a conservative approach to managing our balance sheet, and we will be nimble to ensure adequate liquidity as needed. As John discussed, our disposition plan is likely delayed with a timing unknown at this time. The retail rent relief program will have a minor earnings impact. From a cash perspective, one month of rent deferral for these tenants is approximately $1.5 million. Non-contractual parking income totals approximately $1.5 million of NOI per month. We expect the impact from this revenue stream to be closely tied to the shelter-in-place timeframe. Across the residential portfolio, we expect limited NOI at one Paseo and some occupancy declines at Columbia Square. While it appears that we are on track as originally contemplated with revenue recognition on our development projects, shelter-in-place ordinances and availability of manpower may impact this. Our best estimate at this point is as follows. In Hollywood, Netflix on Vine is on track to deliver in the fourth quarter, and the On Vine residential tower is scheduled for the first quarter of 2021. In San Diego, the remaining 146 residential units at 1 Paseo are estimated to deliver late in the second quarter of this year, And one Paseo office is scheduled to deliver in phases starting late in the third quarter. And in Seattle, we expect the first phase of 333 Dexter, totaling about 330,000 square feet, to begin revenue recognition late in the third quarter of this year. Finally, across our stabilized portfolio, we have several buildings that are undergoing tenant improvement work prior to the new tenants taking occupancy. For a time, about 30% of our TI projects were facing delayed completions. But those ordinances will be lifted as of May 4th, and it appears this is now behind us. That completes my remarks. Now we'll be happy to take your questions. Operator? Operator?

Yes, thank you. We will now begin the question and answer session. To ask a question, you may press star, then 1 on your touchtone phone. To withdraw your question, please press star then two. At this time, please pause momentarily while we will assemble a roster. And the first question today comes from Jason Green with Evercore.

Good morning. Just a question on the private placement. Are you able to provide how much more expensive that would have been had you issued unsecured debt to the broader market and also how deep the private placement market is today for the right companies?

Yeah, I mean, one of the reasons we didn't do public bonds was the market is very volatile right now, and the pricing discovery was unsure. So to be honest, it's hard to know exactly what the range would have been. But, you know, it's fairly close to the private placement. We did, you know, four and a quarter effectively on our deal, and it may have been a little bit lower, you know, if we hit the right day on the public side, but it also could have been higher. So we don't have a lot of more visibility than that.

Got it. And then for the 3% of revenue from retail tenants, are you able to provide what collections were for those specific tenants?

Obviously, we didn't bill for the tenants we gave rent relief for, so we didn't collect any of that. For the rents that we did bill for, we collected about 80%. Okay. Thank you.

Thank you. And the next question comes from Craig Mailman with KeyBank Capital Markets.

Hey, guys. Tyler, just on the kind of the cash accounting transition for those tenants, had they not paid in March either, and that's why you guys recognize it in one queue, or they kind of came to a recognition they wouldn't pay in April?

Well, for the co-working tenant, they paid in March, but, you know, we don't want to get into the specific negotiations with all these tenants, but it was more of an April issue for the co-working tenant, and and our expectations for how that might play out. And with the retail tenants, we were having some issues with those tenants already.

That's helpful. Then, John, maybe just bigger picture. I know it's very early with everything going on, but kind of West Coast tenancy, early adopters of work from home relative to most East Coast tenants, but typically more dense. So just curious kind of where you think the rent or office demand could kind of shake out here as the pandemic eases.

Yeah, well, Rob Perron, why don't you handle that and maybe I'll follow up.

Sure. How are you doing, Craig? You know, again, we're kind of right in the middle of this and focused on getting, you know, our tenants back to work with their employees safely. But when you really look at what's going to happen, I think is that If you take, for example, a company that's got 100 square feet per person right now, maybe they'll be looking at 150 square feet per person in the future. We don't know what offset we're working from home have. Very hard to answer, but I can say with certainty that in the business sectors we focus on, whether it's life science, you can't create a virus or vaccine – excuse me, a vaccine – working from home. You can't create a Hollywood blockbuster film working from home, and nor can you develop state-of-the-art software. So I think that working from home has probably been more legitimized than it ever has been, but I think it's not going to completely offset the increase in space I think that tenants are going to need in order to function going forward. So hard to say where we end up with this, but I'm confident that at least in the portfolio that Kilroy has that John outlined in his remarks, you know, these firms are going to need to and want to get back into the workplace.

That's helpful. And then just one last one. The development pipeline is well leased here and you guys clearly have, you know, additional projects that could have started this cycle. Just, Um, thoughts on, you know, something like the flower Mart here, if that gets delayed till next cycle, then just also, as you guys think about the risk reward of spec versus maybe, um, being able to pick off some opportunities, if there's distress here, should we expect that maybe, uh, the balance of power kind of moves back to, to acquisitions versus.

Well, I don't know about acquisitions right now because I haven't seen it sufficient information with regard to opportunities of the kind of quality assets and locations. that we like where there's a price that we like. To the contrary, we've seen on the deals that have closed that continue to close at very low cap rates and not the kind of upside we want. So it's too early to tell on acquisitions. Obviously, we were, I think, the earliest and probably the most aggressive in 2010 when we could see that that recession was... going to see some daylight, and if those opportunities present themselves, who will? On the question of development, as we commented on in our earlier remarks, we are 90% leased on office and life science. The 10% was just started this summer. That's the Kettner project down in Little Italy, a sub-market of San Diego, and I'm confident that's going to lease up while it's under construction. In terms of spec development, You've seen us in the past be aggressive on spec development, but always balancing, not just building more and more spec, always making sure we were getting either things pre-leased substantially or that stuff we'd started was under construction before starting new spec. Clearly, the bias now versus two or three months ago is to be far more conservative on spec development. I see no potential for us starting any spec development. for, you know, within the next 12 months. And I don't know that we'll start any development within the next 12 months, even if it's leased.

Great. Thank you. Thank you. And the next question comes from Jimmy Feldman with Bank of America.

Great. Thank you. I guess, John, going back to some of your comments about some of the hygiene upgrades, I think you mentioned you hired a hygienist and You're focusing on upgrading assets. As you talk to tenants, what do you think the costs are to start getting buildings ready, both for the near term and then just kind of longer term changes in design that we might start to see?

Yeah, that's a really big question. We have a task force at Kilroy that consists of 12 people. It includes our chief engineer who comes out of the life science biotech area and is one of the real leaders there. So this is really familiar ground for him. One of the things we've been doing, Rob and others in our asset management people have been meeting regularly or meeting virtually regularly with our tenant base, both in the tech, the life science, as well as the general, you know, other populations about what protocols their companies are developing. And as you know, in our portfolio, we have buildings that are leased exclusively to tenants. And then we have some that are multi-tenant. And so it may differ a little bit. But I would get into a long list and a long litany, Jamie, of the things that we're doing. Some of them, I don't want to tell our competitors what we're doing because I intend to lead this. And just like we've been the leader in sustainability, we intend to lead the new wave, if you will, in this area. But we are doing the simple things like we have robots that clean the filtration systems, the air conditioning conduit and so forth. We may end up with clean rooms in buildings where everything's got to go through it. We'll see about that. We have engaged hygienists, as I said. We're working on where all the logical places are to minimize touch and then to make sure that we are cleaning things appropriately and so forth. So these are all sort of the things that are happening right now. We're working with our tenant base as they re populate these buildings. Most of the big tenants are not intending from what we've been told to go back and say, okay, all a hundred percent of the population of this building is going to arrive on day one. They're going to phase it with the most essential operations. And again, And then on the spacing side of things, we're working with tenants, some of whom want to rearrange and have more square footage per person. And then on the design side of it, you have sort of three things going on. One is the core portfolio. Most of ours is very new, as you know, so it comports with many of the things that people want, which is more air conditioning capacity. you know, greater width in stairwells, greater building floor-to-floor heights, more open spaces. You're going to see terraces and rooftop decks and controlled open spaces become far more valuable from everything we're hearing with our tenant base. So we think we're well positioned with many of our projects because they embrace all those things. There will be some, you know, we already pressurize our lobbies in various ways. That may change. So we're really getting a tremendous amount of input, not always the same, from our various tech and life science companies, and we're putting together our own protocol. So this is going to be an ongoing process, but we intend, as I say, to be a leader in this response and effort.

All right. That's very helpful.

Thank you. You're welcome. Yeah.

Thinking about the different submarkets in the Bay Area, CBD San Francisco, Peninsula, Silicon Valley, can you give us a sense of how those different submarkets are behaving differently and how the tenant base is dictating that? We see headlines coming out of CBD San Francisco about higher sublease space in the first quarter and layoff announcements seem to be more concentrated there, but Just from, you know, you guys are clearly on the ground. I'd love to get more of your thoughts on how those three areas are really differing right now.

Yeah, Rob, do you want to take that one?

Sure. Hi, Jeanne. You know, I'll start with San Francisco. Unfortunately, the way the quarter fell between, you know, March and April, several transactions that were very close or on the cusp of being signed the last day of March spilled over to April. So, And a lot of that was in sublease space, but also there have been some significant renewals that were done to the tune of about 500, almost 600,000 square feet that fell right between the 30th and the 1st. So the data doesn't really show, I think, what the reality is in terms of just pure activity. You know, there's no doubt that there's sublease space will come to market, but from what we're seeing in conversations we're having, with a variety of folks, whether it be tenants that are subleasing or brokers or other owners, quality sublease space, as we've always said, is getting activity and is getting into significant documentation. And those numbers I just went over in terms of sublease space do not include the Macy's.com space, which is terrific space. And I don't know Macy's strategy, but I assume they're probably trying to find a large single tenant because that building would be perfect for that. Um, you know, on the, on the, in the Valley, uh, where things are a little less dense in terms of just, you know, buildings, how buildings are laid out and that kind of thing. Um, you know, we have several companies that we've been talking to, uh, real time that are looking at a lot of the things John was talking about just in terms of getting people back to work. They're not talking about, putting space on the market, but they're looking at pretty innovative ways to get their own employees into the work environment safely. So thermal imaging and that kind of thing. But in terms of the Valley itself, there have been on the capital side, there have been some deals that were put on hold in terms of just acquisition and that kind of thing. But from a leasing perspective, we are again, right in the middle of this COVID thing. So it's Much like San Francisco, there is activity. It's just sporadic.

Okay. Do you think the shape of the downturn and this recession, do you think it hits one of these, Silicon Valley any more or less than CBD San Francisco? Or do you think it would be pretty equal?

I think it's going to be interesting. I mean, I think I could, you know, like we've seen in Seattle and obviously in Silicon Valley and San Francisco, I think this radial approach to occupancy will become more popular, meaning you may see less fully occupied dense campuses and more satellite type offices. But again, I would kind of go back to, if you look, if you look at our premise about the Silicon Valley, it's always been The has and the have not. So, you know, those properties that are near transit lines and easily accessible and amenities and that kind of thing are still going to be the ones that I think lead any kind of recovery. Just, you know, the world isn't going to stop and people will want amenities and, you know, they will be going out to dinner and that sort of thing in the future.

I think in the have and have nots, Jamie, where we would expect to see this, I use the term flight to quality in my prepared remarks. And you're going to, I think based on everything we're hearing from our big tenants, the focus is going to be on buildings they control, landlords that will work with them to introduce and enforce their protocols, particularly if they happen to be in a multi-tenant building. Buildings that have the kinds of things you need to have in order to have greater separation, which, again, is higher ceiling height, greater ventilation systems, wider stairwells, added elevator capacity. I think there'll be a potential advantage for shorter buildings versus taller buildings just because of travel times and elevators and whatnot and people, you know, the whole social distancing thing. And the wellness and... and all the other things that are going to play into this. So in most cases, modern buildings are going to perform, I think, much better if they're in the right location compared to older buildings.

Okay, great. Thank you both for your thoughts.

Thank you. And the next question comes from Nick Ulico with Scotiabank.

Thanks. I guess I just wanted to first go back to the co-working tenant where you had it go to cash basis reporting. Can you just give us a feel for what drove that and how we should think about the rest of the co-working tenancy, which I know you said I think is just under 2% of revenue, how confident you feel in terms of getting that rent right now?

Well, I can cover the economics, and John can talk about co-working in general. But in terms of, you know, as you said, we don't have a lot. It's 1.8% of our revenues. It's really just three tenants throughout the portfolio, one in L.A., one in San Francisco, and a little bit actually in San Diego and Seattle, I guess. But with that one tenant, as I mentioned earlier, they paid March, but they did not pay April. And we felt that it was the right thing to do to reverse all the straight lines rent and any accounts receivable that was outstanding at that point. So that's why we did what we did based on our view of how it may play out over time. And with the other tenants, one of them has paid rent and one of them we're negotiating with.

Just in terms of thoughts on co-working, I believe the two smaller co-workers we have are in buildings that we bought that had those tenants. The only one we did directly was the one in Hollywood, which is tremendous space. And if we were to get that back, we'd do extremely well with it, take a little time to reposition. But I've made no bones about it. I've never really come out and condemned co-working. I've regularly, either myself or Rob or Todd or whomever, I have shared with you that we're just not believers in it. We'd ever liked the idea that you didn't really have a credit entity. You have this rapid expansion going on, which, you know, with companies that weren't making any money, I'm old fashioned. I like companies that make money and can pay rent. I've been, you know, through a bunch of these recessions and I can tell you that that's a much better situation than the alternative. I never liked the idea that we were putting up the capital for somebody else to create a positive arbitrage for themselves. I didn't like the fact that you had so many people coming in the building, you didn't know who they were. And so we're very fortunate that we don't have big exposure there. And in terms of where this goes, there are others that have a lot more exposure to it, and they probably have thought it through a bit more than I. I know that with our big tenants, some of whom have used the enterprise version of that, which works well for them. But some of their concerns are who else is in the building and how do we make sure that that building, if it's multi-tenant, adopts and everybody adopts the protocols that those bigger tenants have. And so, you know, this is going to play out over time and we'll see how it works. I'm just glad we don't have a lot of the co-working space in our portfolio.

Okay, that's helpful. Thanks. Just one other question is on, you know, as we think about your portfolio, and maybe we can just get a little update on, you know, the exposure to, you know, bigger tenants versus smaller tenants. And as we're thinking about some of the smaller tenants in the portfolio, you know, do you have any early indication you can give us in terms of, you know, potential credit issue on collectible rents? just kind of thinking about the piece of the portfolio that is smaller tenants that aren't as well capitalized.

Yeah, I can start there. So as we said, you can break it into pieces. The top 15 tenants make up about 50% of our revenues, and they're all strong companies. Another 25%, as I said in my remarks, of our revenues come from the other companies that are publicly traded, investment-grade, or sponsored. So it's really just the 5% at the bottom that are startups, VC-backed tenants that probably are a little bit more at risk. As I said in my comments, if you exclude co-working, we collected 97% of our office rent. So we haven't had a lot of issues to date. Obviously, it's going to play out over the next couple months and we'll see what happens, but we feel we're pretty well positioned on this given the quality of the tenant base.

Okay, appreciate it. Thank you.

Thank you. And the next question comes from John Kim with BMO Capital Markets.

Thanks. Good morning. Tyler, looking at your 2020 assumptions, it appears that development and the revenue recognition is really the main item of uncertainty. I just want to make sure that was the case. And then secondly, I wanted to know if you had could provide any color in occupancy. You're at 97% lease today. You have 4% expiring this year. Is 93% truly the floor where occupancy can end up?

Yeah, on the latter one, I mean, we are not giving guidance, so I'm not going to get into specifics, but no, I don't think it's the floor. I mean, that's the issue. That's why we're not giving guidance, which goes back to your first question. I mean, I think the other piece of where, you know, there is revenue recognition, there is developments coming online, But we just don't know how the office business is going to be impacted over the next several months and how fast it will come back and if we will have other tenant issues. And so for those reasons, we can't really give guidance, and we don't know what our occupancy is going to be. I mean, I think it's in that range, but there's certainly the possibility that it could be lower than that. We don't think substantially, and it may not at all. I mean, we're hoping we come back to that number soon. at the end of the year, but we'll just have to see.

Yeah, the way I'd say it is that we don't have the expectation of being lower, but these are unprecedented times and bad stuff can happen. We're not seeing the bad stuff other than as we've expressed on this call with regard to various segments, particularly of the non-office life science part of the business, but it's just uncertain.

On Flower Mart, it looks like the Prop M guidelines state a requirement to begin construction within 18 months. Do you anticipate receiving an extension on this, or is this a pretty loose definition?

No, that's not the case. Okay. Thank you.

Thank you. And the next question comes from with Wells Fargo.

Great, thanks. John, do you have any concern about the level of supply that's going to be coming to the market in Seattle over the next few years, not just in Seattle proper, but also in Bellevue? I mean, it seemed as though the demand level was more than enough to support all of the oncoming supply pre-COVID. But I guess, has your view changed of the risk in that market at all?

Well, I think our view has changed in all markets to much more of a wait and see versus everything is rosy and proceed. You're quite right that the percentage of new development that is scheduled for some of which is under construction in Bellevue is unprecedented and is a significant amount of, you know, as a percentage of the current supply. Rob, maybe you can handle this a little bit, but it's about 70% pre-lease of the stuff that's under construction. Is that correct in Bellevue?

Yeah, and there are some transactions pending that are quite large, over a million feet with one company right now. I just can't name names, but the supply in Bellevue is traditionally has been something we've watched very closely in terms of just having to compete against that. But if you look at our portfolio specifically, we're pretty locked up.

If you've, if you've noticed, we have not made any announcements about buying any development sites in Bellevue while others have been buying and some preleased and that's great, but we have not, we have nothing from a development standpoint in Bellevue. and I don't anticipate us having anything unless there was some extraordinary opportunity. With the one development site we have, other than a couple little tiny ones next to 333 Dexter, which are 6,000 and 12,000 square foot lots, is the property that we bought called the formerly known as Advance. I guess it's still known as Advance Parcels. That's going to take about two years for all the entitlement. We have a terrific land FAR basis there. And so, you know, if the market's still lousy in two years, we'll sit on the land. But in the meantime, we'll get it entitled appropriately and work all that stuff out, be ready to pull the trigger, win it if it makes sense.

Got it. Very helpful. And then out of curiosity, can you talk about what led to the earlier than expected revenue recognition at the exchange? I think You know, last quarter the expectation was to have a Phase 3 recognition in the third quarter, but it seems as though they took the space here in the first quarter. You know, I'm assuming they took occupancy before the crisis, but, you know, any color or commentary on that would be helpful.

Yeah, no, as you say, they just were able to get in more quickly. They wanted to get into the space, and they completed the work ahead of schedule, and so it came in ahead of our numbers. Nothing more complicated than that.

All right, thanks. And then the last one, you know, it looked like CapEx per square foot and concessions in general were a little lower this quarter. Can you just talk about whether that was a mixed issue? And I guess maybe for Rob more generally, are you expecting to see a trend lower with respect to TI's and pre-rent in your markets?

I'll handle the latter, and Tyler, maybe you can touch on the former. But as far as the latter goes, in terms of more ti or less ti it's you know it's hard to predict right now i mean i think that uh construction you know if things continue in the way they have construction pricing may come down and and tenant improvements therefore would as well um in terms of just anything that we see i think it's really just maybe a longer construction period for certain projects but already we're seeing that cities are allowed to start construction again, particularly in San Francisco. So hard to predict.

Yeah, in the area of construction right now, with the equivalent of social distancing or whatever they call for construction, there are new guidelines. And so That could very well slow things down a little bit because it could mean that instead of having perhaps 200 people on a job, you have 170 people. We just don't have any experience with it yet. It's too soon to tell. And, you know, all the cities are trying to figure this stuff out as well. One thing that does trouble me, and I don't know, just intellectually, and I don't know if it will become a problem, I think what you'll see is a lot less construction. and I think you'll see potential slowdowns in planning departments and whatnot because these cities are all getting clobbered in the revenue side, and we don't know how that plays out. It doesn't impact us with regard to, maybe modestly with regard to future tenant improvement work or something, but it doesn't impact us right now with regard to any development we have going on, Does it in the future? I don't know. This is all going to play out over time, and I don't think anybody has a sufficiently clear – there's no crystal ball here. All right, great. Thanks, guys.

Thank you. And the next question comes from Andy Corsham with Citi.

Hey, everyone. Tyler, you talked about doing the entire – like a forward equity, but I don't think you necessarily mentioned why you guys chose to do that. Was it something in the contract that forced you to do it? Was it just that you felt better having cash than a forward equity contract out there? Was there a deal that maybe you're targeting and want to have the capital ready to go? So why do it all now?

Yeah, no, there was nothing in the contract that forced us to do it. It was just that an abundance of caution given the situation. We felt having the immediately available cash was the right thing to do, and by drawing down the equity, we didn't increase our leverage at the same time. I mean, we could have drawn the bank line, but that would have increased our leverage amount, and we felt it was more conservative to draw down the equity. So it was just an abundance of caution, being conservative, and knowing that we would have the cash available to complete our development if things got crazy.

Thanks. And Rob, maybe going back to a point you made, I think you talked about you know, tenants or maybe users being hesitant on a large, massive assets or campuses, I think is the term you use. And then you're building Flower Mart, which seems like a big campus for maybe one, maybe two tenants. How do you balance those two thoughts? Do tenants want to have all their employees together or would they prefer to split them up amongst assets or buildings?

you know, hard to predict, but I think the flower mart, the beauty of the flower mart is it's, you know, you could do one large tenant, but you can do five, six or seven tenants. So, and they are separate and distinct blocks of space. So for an urban setting, it's actually, uh, a much more spread out, if you will, uh, format than a high rise. And when you back to one of John's earlier comments, if you look at something like the flower mart, we have so many fewer, um, elevator travel times, meaning if people are going to restrict the number of people getting in cabs, that's going to have an impact on high rises. And Flower Mart, with its layout, is, I think, perfectly suited for accommodating whatever the new world brings in terms of just elevator density and capacity. So I see Flower Mart as something that's in an urban setting like San Francisco or Manhattan or what have you, something that's actually more spread out than a typical office environment.

To put that in perspective, the Flower Mart, when it's fully built out, is the equivalent of almost two Salesforce towers, but it's in five buildings, the tallest of which I think is 15 stories.

Thank you. And the next question comes from John Ghani with Stateful.

Great. Thank you. Big picture, John, state of California has been really aggressive on stay in place, very aggressive on residential tenant relief. Long-term impact on the political environment in California. Do you think this turns California to the right or the left or no change?

Oh my God, John, I wish I knew the answers to that. I've been trying to figure that one out and influence it for most of my life. And, and, uh, you know, that little thing about you stick your finger in jello, you try to reshape, you pull it out. It looks exactly the same. Uh, I kind of, I kind of, I kind of wonder if it, you know, if that's a good, uh, analogy. Um, I think the, um, What I'm hopeful of here is that California has had its share of problems, some of them self-inflicted. I am seeing more dialogue between the political parties and between businesses and the unions. There's always going to be rancor. They're always going to stir it up for elections and whatnot. But I'm hopeful, and this may be just hope and not become reality, but I'm hopeful that that people are going to see that we need to be able to work together and we need to have good protocols on this stuff. I do compliment the state and the city of San Francisco and some of the other cities for taking aggressive action on this to begin with. You could criticize any particular aspect of it, just like you can criticize so many of the things the federal government has done and whatnot. But they're trying their best. There's some cities that I think have in California have been jerks, and I won't mention who they are, but they're more south than north and not too far south. I just don't know how it will work on the public side of things. That's a question. If I knew the answer to that, you know, everybody would be asking me and probably paying me. I do think that there is going to be a move towards probably that will legislatively become more prevalent for future buildings, the wellness aspect of it, the thoughtfulness with regard to how they perform and the kind of filtration systems and so forth they have to have. Where that goes, I'm not sure, but I think it's probably a logical fallout from this. I'm just so thankful we don't own a lot of older stock. The older stock that we do own was, you know, stuff that we could make into, you know, ultra-modern buildings, maybe not on the facade, but on the inside. And I just think there's going to be a real have versus have not in the flight to quality. And quality is not just fancier, you know, chandeliers. It's more in the systems and things I talked about before.

And then a little follow-up, any thinking on split roll Prop 13? Does it get tabled? Is it still on the ballot in November? How does that shake out?

You want to handle that, Donner?

Yeah. Yeah, no, it's still on the ballot. They went back and got more signatures on a slightly adjusted proposal. But the good news is what we're hearing anyway from our advisors is that it's polling worse than it did before. I think businesses and people are tired of the higher taxes. And so, you know, we'll see. But it's still on the ballot, but a long way to go before November. But the polling is getting worse for them.

Okay. Thank you. Good luck. Thanks. Thank you.

Thank you. And the next question comes from Tyra Kusana with Mizuho.

Yes, just a quick follow-up on the retail side. How are you guys kind of thinking about kind of bad debt expense related to retail given, again, the number of retail tenants that have paid rent and some of them asking for rent relief or rent abatement?

Yeah, you probably know under the new lease accounting, there really is no such thing anymore as bad debt expense. And so what you do is you reverse your revenues. It's in revenues. And so that's what we did in the first quarter. We... for those two tenants that we talked about, and we'll just have to see how it goes for the rest of the retail portfolio over time. But we have our eye on that, and as we said, we have a deferral or a rent relief program for 90% of those tenants, and we'll be monitoring that. But if they're not going to pay their rent over time, then we'll have to adjust in revenues.

Okay. Yeah, sorry. Yeah, this is John Kilroy. I was going to say with regard to retail, remember, we lump retail in to show, to reflect what percentage of revenue it is, but most of our retail are, you know, like an optical shop or a restaurant or something in an office building. The only concentration we really have of retail is at One Paseo, which is brand new, you know, big open-air area, single level, no escalators. You know, no enclosure. It's the kind of retail that people want, and it's the kind of physical plant where you can be more, you know, socially distanced or whatever the term is today. So it's going to take a while for retail to come back. I think restaurants, you know, people are going to have a – I'm not sure anybody wants to go eat in a crowded restaurant right now, so that's going to take a little while to come back. It's just too difficult to predict when we'll achieve rent collection. But as Tyler said, we're going to work with these folks.

Understood. And then the two months of rent relief that's being given, are you just tacking on two months more onto the lease, or is it possible it's going to get more termed?

Well, in some cases, there'll be a negotiation. That's what we've offered just because we knew they weren't going to be able to withstand this. Our view is that most of our retailers are amenities to our office life science or residence, as the case may be, and we want to work with them. We're not going to let them pants us, but we do want to work with them. And, uh, in some cases it'll simply be, and in most cases it's going to be, we gave them two months of relief. They had two months of extension. Do we have to give them more relief depending upon the circumstances? We'll, we'll, if, if somebody didn't like the two months and the two months add on, then we might customize it, do something a little different. So it's gonna, you know, that's all going to play out. It's not a lot of square footage. It's not a lot of transactions, uh, but we have a team working on it, and we should be able to address more, I would think, by the next call. Great.

Thank you, and good luck. Thank you.

Thank you. And the next question comes from Dan Ismail with Green Street Advisors.

John, just wanted to follow up from a prior statement on state and local budgets, which are clearly under pressure in this environment and might be a driver of new permitting or rezoning of areas to short budgets. I know this is likely not a near-term issue, but are there any opportunities here for Kilroy, thinking of the Blackwater site in particular?

Yeah, I don't want to go far down that road, Dan. Let's just say that we have a team of people working on a variety of things that are kind of in the confines of your question. And, you know, who knows how this is going to play out? As you know, California is a very complicated place. It's very easy to file a lawsuit. One of the things that I hope will happen now, is that, and will it at the margin or will it, you know, more seriously, you know, can we get rid of some of the nimbyism that has made it so difficult to get things done, particularly when we know that we have to build more housing in the state, we have to build more apartments in the state, we have to be able, you know, to deal with the growth that we continue to have And does that translate into more efficient planning policies? More to come. I'm hoping. But remember my jello comment.

Got it. And just on construction pricing, you know, I understand that things are very difficult to predict in this environment, but they've been rising, call it, you know, low to mid single digits the last few years. And just what's happening with oil and other commodities, Is it your expectation for that trend to reverse?

Yeah, I think so. But again, there's no real data of substance or of, you know, enough things to, you know, to confirm that. But if you look at the architectural book or whatever they call it, or as we do, we also talk with, you know, we do business with probably 20 major architectural firms that are either headquartered here or international. And most of them will tell you that their book of business has dried up. So that tells me that you're going to end up with a lot less construction and for, you know, the oil and other commodities you mentioned, it seems to me that that's likely to lower costs somewhat, or at least lower the growth in costs. Labor is the other thing that's, you know, a big driver of this stuff. And I'm not sure labor costs are going to go down. Um, and then don't know the implications that I mentioned earlier. I think at the margin it's not going to be a big impact, but the fact that you may not be able to build certain things as quickly because of the new rules with regard to how close construction people can be and so forth. I mean, there's all these little things that just don't know how to answer.

Got it. Thanks, John.

You're welcome.

Thank you. And the next question comes from Dave Rogers with Baird.

Yeah, good afternoon, everybody. First question maybe for Tyler, just to follow up with something John had said earlier about maybe being more conservative on development, no spec development, and maybe no development. At what point in that process maybe do you have to think about the capitalization and things like the Flower Mart land and improvement, KOP-based, you know, future phases in that process?

Yeah. So if we completely stop work and don't do any, you know, development work or entitlement work or permitting work, then we would have to evaluate whether we need to stop capitalizing interest. But, you know, clearly we're not in that mode at all. As John said, we're going to get our projects ready to go. We just may not kick them off. And so if, you know, a year or two from now, we're all ready to go because it's going to take a while on all these projects, you know, and then the market's still not ready, then we'll have to address it at that point. But, It's probably more of a medium to longer-term issue.

That's helpful. I appreciate that. And then, John, maybe one follow-up, and I did get kicked off the call for a bit, so if I missed this, I apologize. But San Diego is a much smaller portion of your portfolio today, and you've done a great job of kind of repositioning out. But I just – last cycle, that was a particularly hard-hit area for you with the number of vacant buildings. Can you kind of talk about how you feel about credit San Diego and just kind of the overall market down there today versus maybe what we saw in the last cycle?

Yeah, well, you know, I mean, and you commented on, we got out of Sorrento Mesa, we got out of I-15 with the exception of Kilroy Sabre Springs, where it's mostly credit tenants. And we, you know, we got out of Mission Valley and all the rest. So our concentration is there in Carmel Valley, Del Mar Heights, a little bit out on the I-15 with Kilroy Sabre Springs. And then, of course, UTC area. And then we have the development site underway in Little Italy. And the credit quality of our tenants in San Diego is demonstrably higher. I'd say across the board, and Tyler, jump in here. You know, if you think about where Kilroy was in 2008 in San Diego, we had a lot of tenants that weren't that high credit. We had a lot of lease expirations coming up. And I think we went from like 99% lease to somewhere in the 70s in about a year and a half period. We had so many terminations. Part of that was because of the fact that we acquired a lot of properties as well as done a lot of leasing. It just happened to be concurrent. So we have much better lease expiration profile in San Diego and across the company. We have a much better credit profile in San Diego and across the company as We have a much higher quality of building in San Diego, that flight to quality thing that I mentioned. And we're very well leased in San Diego. And so much of that's been done over the last couple of years. So, you know, I don't want to say I'm a karma guy. I want to be careful what I say because you might find that you turn the tide. But I think we feel pretty good about most of our tenants and the quality of of the enterprise and the quality of the people. That's the other thing. I think we have a far better team. So I'm pretty hopeful that San Diego is going to continue to be a winner. If you look at some of the deals we've done down there, it's been extremely high credit. You know, we did, you know, one Paseo is all, you know, the, the JP Morgan's bank of America, Deloitte to that, that level of quality. And then the other stuff in Del Mar is very high quality as well. And of course, uh, I can't tell you who the tenant is. Everybody knows, but I'm not supposed to say who took, uh, the building. I forget what we call it. The town center drive building, which is one of the top 50 companies in the world. Um, so we'll see.

I appreciate all the.

Thank you. And as that's all the time we have for questions right now, we'd like to return the floor to Tyler Rose for any closing comments.

Thank you for joining us today. We appreciate your continuing interest in KRC, and we wish you all remain healthy and safe. Thank you very much.

Thank you. The conference is now concluded. Thank you for attending today's presentation. May now disconnect your lines.