Kilroy Realty Corporation

Good day and welcome to the second quarter 2021 Kilroy Realty Corporation earnings conference call. All participants will be in a 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. And to withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Ms. Michelle Ngo, Chief Financial Officer. Please go ahead.

Good morning, everyone. Thank you for joining us. On the call with me today are John Kilroy, Tyler Rose, Rob Peratt, and Elliot Trencher. 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 on this call and in the supplementals. This call is being telecast live on our website and will be available for replay for the next eight days, both by phone and over the internet. Our earnings release and supplemental package have been filed on a form 8K with the SEC, and both are also available on our website. John will start the call with business conditions in our market and then review our operational and strategic activities. I will discuss second quarter financial results and provide you with earnings guidance for 2021. then we'll be happy to take your questions. John?

Thank you, Michelle. Hello, everybody. Thank you for joining us today. We've had an extremely active and productive period since our last call. We signed several large long-term leases at strong rental rates. We've continued to expand our life science portfolio, and we've completed four acquisitions that continue to position us for future growth. Before I review the acquisitions, let me share our view on current market conditions. I'm happy to report that Kilroy's workforce is fully back in the office, and we are excited that more and more of our tenants are joining us. It is clear the U.S. economy is rebounding more quickly than expected. Every week brings more tenant leasing discussions and more requests for property tours. We are seeing strong job creation, high levels of capital investment, continued expansion, and healthy financial performance from our major tenants, and increasingly so from our mid to smaller tenants. And we continue to see high-quality, well-located assets in our markets that are commanding strong valuations with record pricing. These factors are translating into increased leasing activity in office and residential, as well as continued strength in our growing life science portfolio. Starting with office, Data on broader rent levels remains limited, but the information we do see suggests that office rents in our markets for premier quality properties and locations did not decline materially from pre-COVID levels, and some of our projects' rents are increasing once again. In San Diego, we recently executed a definitive agreement with a major technology company to develop and lease a 71,000 square foot office project in a market where rents have reached all-time highs. Construction should commence later this year. We are also happy to report that the office component of our Juan Paseo project is now fully leased. The recent lease rates reflect all-time highs for the market and have risen approximately 25% from our original underwriting. Juan Paseo and the 71,000 square foot project demonstrates our ability to continue creating significant value by developing well-located, world-class office projects. And finally, in Seattle, also in the second quarter, we signed a 57,000-square-foot, seven-and-a-half-year lease with a gaming company at our Key Center project at an all-time high rental rate for the Bellevue market. The rent was 25% higher on a cash basis and 55% higher on a gap basis compared to the prior lease. Bellevue remains one of the strongest markets in the country, anchored by Amazon, but with plenty of depth from other technology and gaming companies. Moving to life science, fundamentals continue to outperform, starting in San Diego. Vacancy rates in Torrey Pines and University Town Center are incredibly low at less than 2%, and rents are up 15% to 20% year over year and are at all-time highs. The lack of availability in these two submarkets has forced life science companies to expand into the adjacent areas of Sorrento Mesa, Del Mar Heights, and along the 56th Freeway. As an example, earlier this month in Del Mar Heights, we signed a 10-year, 96,000 square foot, full building lease with Dermtech, a publicly traded life science company at our 12340 El Camino Real property The building will serve as the company's new headquarters as it expands its footprint in the market. And we are in detailed negotiations on another 200,000 square feet of life science transactions, also in Del Mar Heights. In UTC, we are in the final stages of lease negotiations with another publicly traded life science company for a 10-year, 51,000 square foot, full building lease at our 4690 Executive Drive project slated for redevelopment in early 2022. These transactions are in properties to be converted to live science and will have mark-to-market rent increases of more than 50 percent, highlighting the low-risk, high-return conversion opportunities embedded in Kilroy's existing San Diego office properties. It is important to note that our success in these conversions is in part due to our intense focus on quality and buildings that have the right layout and physicality to accommodate different uses. As mentioned, lifetime demand is moving north to Delmar Heights and east along the 56 corridor where a major life science company has committed to lease a 500,000 square foot spec project nearing completion in close proximity to our Santa Fe Summit development project. As a reminder, We have full entitlements to build between 600,000 and 700,000 square feet of life science products on Santa Fe Summit Phases 2 and 3. We are evaluating the commencement of construction on at least one phase for later this year. Moving to South San Francisco, life science fundamentals continue to tighten with vacancy rates less than 1.5% and rents at all-time highs. In June, we commenced construction on the second phase of our roughly 50-acre, 3 million square foot Kilroy Oyster Point Life Science Campus. Phase two follows the successful leasing of phase one, a 570,656,000 square foot project that was fully leased two quarters after commencement. Phase two will include just under 900,000 square feet of space across three buildings and will represent a project total investment of $949 million. Approximately $160 million of that has already been invested. We believe we are ideally positioned with Phase 2 and already in negotiations with several prospective tenants. In summary, we will be delivering 2.5 million square feet of state-of-art life science projects across San Diego and San Francisco in the next five to 30 months. This includes four projects in San Diego, Kilroy Oyster Point Phase 1 and Phase 2 in South San Francisco, and beyond those, Phases 3, 4, and 5 of Kilroy Oyster Point will expand our life science portfolio by an additional 1.5 to 2 million square feet. Adding this all up and combining with our existing life science projects, we will assemble the best-in-class life science portfolio of just under 6 million square feet, with an average age of three years in the best locations. Upon full build-out, life science could be 25 to 30 percent of our total NOI. Now, I'd like to provide an update on our residential portfolio. In San Diego, our one-to-sale project of 608 units is now more than 93 percent leased, which is up from approximately 75 percent leased last quarter and exceeds our prior leasing guidance. Rent levels have increased 15% to 20% since the beginning of the year. And in Hollywood, our latest luxury tower, the Jardine, is now 30% leased just two months since its completion. To sum up our residential portfolio, we now have more than 1,000 luxury residential units between our two Hollywood projects and our San Diego 1 Paseo residential living. On the retail front, our rent deferment program ended in the second quarter, and we're seeing substantial pickup in people traffic as well as in leasing. To summarize our leasing performance, in the first quarter, we signed 200,000 square feet of leases, of which two-thirds were renewals. In the second quarter, we signed 220,000 square feet of leases, of which two-thirds were new leases. This is a good indication of a positive shift in market conditions. And so far this quarter, we signed and have commitments of 170,000 square feet of new leases. At this pace, we expect to return to our pre-COVID quarterly run rate later this year. With that update, let me review our capital allocation activities to date. To recap, in the first quarter, we completed the sale of the exchange for $1.08 billion, or $1,440 per square foot, which was nearly twice our total investment. It was a record price for commercial real estate in San Francisco and provided us with substantial capital for new investment. To date, we have reinvested $680 million across four value-creating projects that provide a combination of accretion, leasing upside, and development opportunity. As we previously reported, In late June, we closed on a $580 million acquisition of Indeed Tower, a newly constructed 734,000-square-foot Class A office property located in the heart of Austin's Central Business District. It is currently 57% leased, with 42% of the space leased through 2034 to Indeed, an investment-grade-rated global recruiting platform. The acquisition immediately established JRC as the fifth-largest Class A office owner in the CBD with arguably the best building in the greater Austin area and provides the opportunity to create additional value through the lease-up of the remaining space in a strong and geographically constrained market. We are excited about our expansion into Austin, a city with all the characteristics and growth potential that we look for when entering a new market. It has a young, well-educated population and contemporary urban culture that is very popular with its large numbers of millennial residents. Austin's broad technology presence is an attraction and strong advantage for us. We know these types of companies. We understand their space requirements, and we've already worked with many of them in developing or adapting properties to meet their needs. With the tech boom in Austin in its early stages, we see these trends continuing. Apple, Tesla, Google, and many others are nearing completion of expanded office spaces, which will bring more jobs to the region and further enhance the technology ecosystem. The acquisition of the D Tower was the perfect way for Kilroy to enter the market. The 36-story property is a unique asset, a highly visible floor-to-ceiling glass tower situated on a full city block, And in the several months since we began underwriting the opportunity, the market has only strengthened, positioning us to exceed our yield expectations. To sum up, the acquisition places us in a state-of-the-art property in a premier sub-market of one of the fastest-growing cities in the country that provides an excellent foundation expanding the greater Austin market and builds a strong operating platform for further growth. It advances our opportunities to partner with many of the leading companies technology companies in the world. Our second investment during the quarter underscores our confidence in the vibrant Little Italy neighborhood of San Diego, just north of the city's downtown. In June, we completed the acquisition of a land site at 2045 Pacific Highway for $42 million. This is a full city block directly adjacent to our 2100 Kettner project and within walking distance of the bay. It is currently entitled to up to 275,000 square feet of office space and will feature panoramic water views from every floor. Combined with our 2100 tetanus project, it creates opportunities for us to offer greater scale and flexibility to the increasing number of companies attracted to this exciting area. Similar to the scale and flexibility we created in Little Italy, we enhanced our land assemblage in the East Village with the acquisition of an $8.5 million land site earlier this year. With this site, we now control two full city blocks entitled for up to 1.2 million square feet of office or up to 1,000 residential units or some combination of the two. Our fourth investment was the purchase of a ground lease underlying our 491,000 square foot key center of office property in Bellevue, Washington, for $47 million. The purchase price equated to $96 on a per-building foot basis in a market where vacant land has traded for double this amount. The ground lease had a remaining term of 72 years, and the ground lease payments were tied to the project's income, which would dramatically increase since the last adjustment. We have now eliminated that exposure as we saw with our recent gaming company leased in this building, will continue to climb in Bellevue, especially for high-quality projects like Key Center. We completed the acquisition earlier this month. These four investments were all off-market, and in each case reflect our disciplined approach to capital allocation decisions and our continued commitment to position our company and our portfolio for the future. To wrap up, we had a very busy first half of the year, We sold a billion-dollar asset and redeployed a portion of the proceeds into projects with meaningful upside and value creation potential. We are expanding our life science portfolio with state-of-the-art development and redevelopment projects that have the proper physicality and are in the best locations. We are seeing strengthening fundamentals, and while we expect market conditions to ebb and flow, there is far more enthusiasm today than any time since the pandemic began. And finally, after years of evaluations, we've entered an exciting market by acquiring the best project in the city of Austin. That completes my remarks. Now it's from the caller, Michelle.