Kilroy Realty Corporation

Hello and welcome to the Q4 2021 Kilroy Realty Corporation Earnings Conference call. My name is Alex and I'll be coordinating the call for today. If you would like to ask a question at the end of the presentation, you can press star 1 on your telephone keypads. If you would like to withdraw your question, you can press star 2. I will now hand over to your host, Michelle Ngo, Chief Financial Officer. Over to you, Michelle.

Good morning, everyone. Thank you for joining us. On the call with me today are John Kilroy, Tyler Rose, Rob Perod, Elliot Trencher, and Bill Hutchinson, Senior Vice President of Investor Relations and Capital Markets, our recent addition to the team. Welcome, Bill. At the outset, I need to say that some of the information we will be discussing during this call 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 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 highlights from 2021 and where we stand today, then move to operational and strategic activities going forward. I will discuss fourth quarter financial results and provide you with initial earnings guidance for 2022. Then we'll be happy to take your questions. John?

Thank you, Michelle. Hello, everyone. Thank you for joining us today. We've always believed that dislocations in the market brings opportunities, and last year we executed on several large opportunities, which I'll discuss later. The disruptions to normal work life created by the pandemic accelerated changes already underway, and we saw all of our key strategies validated. Location, product design, and age, tenant base, wellness, and sustainability have all become vital ingredients in modern high quality properties. As the economy experience fits and starts through 2021, We remain steadfast in our core principles of creating value for our shareholders through development, executing leases, recycling capital into higher growth projects, all while maintaining a strong balance sheet and elevating our leadership position in ESG. I'm proud of our team for delivering a strong performance on all fronts. Now, one month into the new year, evidence continues to grow that COVID is fast becoming a manageable virus. Underlying economic conditions in our markets continue to improve, and the trends that drove market success last year remain firmly in place. Urban neighborhoods that are highly amenitized continue to attract younger, educated workers. That is translated into record residential leasing and all-time high rental rates in some markets, including our One for Sale living project in San Diego, where we are fully occupied. Leasing continues to accelerate at our recently completed Jardine in Hollywood, where we are now just under 85% lease up from around the mid-60s last quarter. Major technology and media companies competing for talent continue to expand, bidding up rents for premium quality workspace that addresses new design, wellness, and sustainability requirements. We continue to see big tech Google, Meta, Apple, TikTok, and many others commit to expanding their real estate footprint in our markets. The continued path of flight to newer, higher quality office properties is supported by record rental rates and price per square foot on investments, activities in our markets. Demand for life science facilities and lab space continues to grow. Vacancy rates are less than 2%. and rural rates are approaching record levels or have exceeded prior records in our markets. VC funding continues to flow into the innovation-driven companies and startups. Our West Coast markets in Austin received a disproportionate share of record funding in 2022. Life science funding was also at record levels. Demand for talent, demand for space, and strong funding continue to underpin the premium asset valuation for high quality in our markets. In light of these drivers, we believe our portfolio, operating platform, and development pipeline will continue to differentiate KRC as the best in class owner, operator, and developer in our markets. Our stabilized portfolio has grown in quality and value. At an average age of 11 years, our office life science and mixed use portfolio is among the youngest portfolios with features that adapt well to our tense evolving needs for flexible multi-use space that offers natural light, fresh air, and outdoor access. It is also an industry-leading portfolio in terms of wellness and sustainability measures. Our portfolio of more than 1,000 luxury residential units in Hollywood and San Diego are performing quite well. We've limited near-term expirations that average 7.1% annually through 2025 and our stabilized portfolio is 93.9% leased. Our in-process development program is well-positioned to drive growth and long-term value creation. We have $2.3 billion in various stages of construction, and 45% is comprised of life science. Once stabilized, we expect this pipeline will generate approximately $165 million of cash in OI annually. With the exception of KOP Phase II, that commenced last year, we expect the NOI to come online within the next 24 months. Our future development pipeline is well diversified by market and product type. It spans the most attractive sub-markets along the West Coast, including our 6-0 project in Seattle, the Flower Market in San Francisco, Kilroy Oyster Point Phases 3 through 5 in South San Francisco, and in San Diego, our East Village and our Pacific Avenue sites. and Santa's Space Summit in San Diego as well along the 56 corridor. Our attractive basis gives us the flexibility to be patient and start construction when conditions make sense. Our rapidly expanding life science platform has vaulted KRC into a leading position in the West Coast's most sought after life science markets. In South San Francisco, we were early in recognizing the tremendous potential value of what is now Kilroy Oyster Point. The 50-acre waterfront property purchased in 2018 will encompass roughly 3 million square feet of state-of-the-art lab space when fully built out. It will represent a total investment of more than $3 billion and is expected to generate an overall cash yield of approximately 7%. Our first development phase at KOP was fully leased within two quarters of our construction start, and we fully stylized it in the fourth quarter. We believe we have created about twice the value of our original investment. The second phase, totaling just under 900,000 square feet, is currently under construction. We expect vertical construction to commence this quarter. In San Diego County, the West Coast's second largest life science market, driven by the region's top universities and medical research centers, We're now operating at frictional vacancy rates with rents reaching historic heights in UTC, Torrey Pines, and Del Mar. The path of growth is now moving further northeast on the 56 corridor where our Santa Fe Summit development site is entitled for approximately 625,000 square feet of life science space in two phases. We expect to initiate construction in the late spring or early summer of this year. and will be on schedule for delivery in approximately 24 to 30 months. In summary, our total life science and health care portfolio on properties we now own will be approximately 5.5 million square feet when completed and fully leased. We will more than double our revenues from life science and health care tenants from 17% to more than 30%, all else being equal. Our entry into Austin opens an important new market for our continued growth. Our $580 million acquisition of Indeed Tower in the second quarter of last year allowed us to grow earnings and will give us the opportunity to create value through additional lease up. Indeed Tower is a fantastic, new, well-located asset that has created a high visibility platform for our future growth in the Southwest region. Austin is a city with all the characteristics and growth potential that we look for. And what we saw in San Francisco in 2010, Seattle, 2011 and Hollywood in 2012. There was a broad technology presence, a young educated workforce, and it is in the early stages of a tremendous growth boom as companies move into the Austin market. Leasing activity is nearing pre-pandemic levels. Rents continue to escalate. Many major technology companies we work with have established or are planning to expand their footprint in the city. Our strong balance sheet gives us an important advantage when opportunities arise. We're able to act quickly and place transactions in a timely manner, and our careful fiscal management has allowed us to increase our dividend for six years in a row, most recently a 4% increase in 2021. That represents a cumulative 48.6% increase since the first quarter of 2016. Lastly, our determination to lead our industry in establishing and meeting increasingly ambitious ESG standards continues to prove its value to our company, our tenants, and our employees. This focus has made us a more innovative, forward-looking company. Time and time again, the industry has recognized us as a leader in sustainability. So while we are proud of these accomplishments, we will continue to look new for doing better ways to engage our communities and minimize our environmental impact. In closing, let me share our five key objectives for 2022. First, complete and lease our remaining in-process development projects as we prepare for new development starts when appropriate, including Santa Fe Summit. Secondly, continue to maximize the value in our operating portfolio proactively managing lease expirations and boosting sustainability and wellness. Third, look for unique external growth opportunities as we monitor market dynamics and evaluate our capital allocation decisions. Fourth, maintain our conservative financial foundation with sufficient liquidity from various sources to allow us to grow. And fifth, continue to work with government agencies and others to positively influence public policy. Once again, we are entering a new year that is sure to be filled with unique challenges and opportunities. We are well positioned to capitalize on opportunities that arise and continue to build a strong, flexible organization capable of delivering long-term value for our shareholders. That completes my remarks. Now I'll turn the call back over to Michelle.

Thank you, John. FFO was $1.05 per share in the fourth quarter, which included a negative 11 cents of early debt redemption costs and positive 6 cents of one-time items related to real estate tax adjustments, repayment of owed rents, and the lease termination fee at 12400 High Bluff Drive in San Diego that we discussed last quarter. Adjusted for this net 5 cents, our fourth quarter FFO per share of $1.10 is $0.12 higher than last quarter, largely driven by the acquisition of West 8th and revenue commencement at Kilroy Oyster Point Phase 1. This adjusted FFO per share is a 12% increase year over year. On a same store basis, fourth quarter cash NOI was up 9.8% and 6.1%, adjusted for $5.5 million of one-time items related to repayment of owed rents and lease termination fees. The positive growth is driven by higher rents on commenced leases and the burn-off of free rent. GAP's same-store NOI was up 10.5%, or 3.5%, adjusted for $6 million of one-time items in the fourth quarter and $3.5 million of COVID-19-related charges in 2020. At the end of the fourth quarter, our stabilized portfolio was 91.9% occupied, and 93.9% leased. Turning to the balance sheet, after the sale of Saber Springs Corporate Center for $37 million, our liquidity today stands at approximately $1.4 billion, including $290 million in cash and full availability of $1.1 billion under the revolver. Our current in-process development and redevelopment program, along with the soon-to-commence Santa Fe Summit, is funded through year-end with cash on hand and projected dispositions. Our net debt to Q4 annualized EBITDA was 5.8 times. Lastly, as John mentioned, our expirations over the next five years remain modest. Specifically in 2022, we have approximately 585,000 square feet or 4% of lease expirations remaining. We had 145,000 square foot tenant in San Diego vacate its space at the end of January. In the third quarter, we have a 65,000 square foot expiration in Los Angeles. It is too soon to tell whether this tenant will renew for a portion or all of the space or vacate entirely. In 2023, the largest expiration is at a recently acquired West 8th project in Seattle, where we underwrote both a renewal and a vacate scenario. More to come. Now let's discuss our 22 guidance provided in yesterday's earnings release. To begin, let me remind you that we approach our near-term performance forecasting with a high degree of caution given all of the uncertainties in today's economy. Our current guidance reflects information and market intelligence as we know it today. Any COVID-related impact or significant shifts in the economy, our markets, tenant demand, construction costs, and new supply going forward could have a meaningful impact on our results in ways not currently reflected in our analysis. Projected revenue recognition dates are subject to several factors that we can't control, including the timing of tenant occupancies. With those caveats, our assumptions for 2022 are as follows. As always, we don't forecast acquisitions. We assume 200 to 500 million dollars of disposition proceeds. Cap interest is expected to be approximately 70 to 80 million, G&A is expected to be approximately $82 to $87 million. Same-store cash NOI growth is expected to be between 4.5% and 5.5%. We expect year-end occupancy of approximately 91% to 92% for the office portfolio and north of 90% for the residential portfolio. Our guidance assumes a steady increase in transient parking revenue starting in the summer. As we've said on prior calls, we expect to pick up about $1 million of revenues a month when we get back to pre-COVID levels. We expect to commence revenue recognition for the following office and life science projects within the following timeframes. At 333 Dexter, we expect the remaining 51% of the 635,000 square foot project to come online by the third quarter. At 2100 Kettner, we are expecting leasing activity on half the project or approximately 100,000 square feet by year end. Across our three life science redevelopment projects, we expect about 250 of the total 330,000 square feet to come online by early fourth quarter. We anticipate development spending of 550 to 650 million on our in-process development and redevelopment projects, including the commencement of Santa Fe Summit. Taking into account all these assumptions, we project 2022 FFO per share to range between $4.35 to $4.55, with a midpoint of $4.45. This midpoint would imply a year-over-year FFO increase of 13% when you add back the debt redemption cost and one-time items in 4Q 2021. This increase is the second highest earnings growth across the past 10 years. To help walk you to this 445 midpoint, we start with our adjusted fourth quarter FFO per share run rate of $1.10 or $4.40 on an annualized basis. We subtract 12 cents of NOI from the midpoint of our projected dispositions in 2022 and the sale of Saber Springs Corporate Center in December of 2021. We add 13 cents from development and redevelopment projects coming online. And lastly, we expect a net positive $0.04 from various items, including pickup from our stabilized portfolio and lower GNA. That completes my remarks. Now we'll be happy to take your questions. Operator?

Thank you. We will now proceed with the Q&A. If you'd like to ask a question, you can press star 1 on your telephone keypads. If you'd like to withdraw your question, you may press star 2. Please ensure you're unmuted locally when asking your question. Our first question for today comes from Nick Ulico from Scotiabank. Nick, your line is now open.

Thanks. Hi, everyone. Maybe a question for John or Rob. Can you just talk a little bit about, you know, latest on, you know, tenants returning to your portfolio? You know, parts of the West Coast have, you know, been slower than some other cities because of COVID. you know, tech decision-making or government mandates. Maybe you can just talk about what you're hearing from tenants on that side and then also how it's affecting, you know, leasing activity in your markets.

Yeah, you want to take that, Ron? Sure. Hi, Nick. How are you? Let me hit on three sort of macro points related to your question. because there are various moving parts to it. I'd say for the first time since the pandemic started and the conversations we're having with executives and business leaders, large employers have really started to communicate formalized plans for people to return to the office. And they've communicated that to their employees in writing as well as in town hall type meetings. And if you look at some of the big tech examples, Amazon, Microsoft, Meta, they have various models of how people are going to come back. But they're basically, despite Omicron, they're basically talking about components of the workforce coming back in mid to end February, March and April. And they're saying that with more conviction than they have at any time in the past, at least in the conversations we're having. And frankly, Interestingly, I think some companies have given up predicting, and it's probably a wise thing to do, and rather than predict, they just start talking to their teams about bringing them back. I think, secondly, in the conversations we're having, a lot of the executives we're talking to have conducted internal surveys with their workforces and have determined that there is a clear difference between the attitude and productivity of employees that have come back versus those that have not. So they are... They are working toward making their office space more attractive to bring those in and get them over that hump of not you know coming into the office. Gensler just conducted a workplace survey of 575 companies, and I think what's interesting in that is the two thirds of the company surveyed are saying they're going to have flexible work policies. but only 9% of those 575 are going to give total control to the employee in terms of where they work and how long they're working from home. And I think the third point I'd like to make to address your question is we're embarking now on what I would call is the great experiment between work from home and the office. And what we're hearing from our clients as well as prospects is that the majority of employers that we're talking to are not talking about a reduction in footprint despite work from home, despite some functions that may be able to work from home indefinitely. They're predicting either a stable footprint or a growing footprint. They're focused on providing hospitality like amenities as we've discussed before. And I think it really comes down to the core actually of John's philosophy on development. You are seeing a flight to quality and that flight to quality is happening not only in our portfolio, but nationally. For example, 400,000 feet with creative artists in Century City consolidating into new development. Sephora and Yelp consolidating into our 350 mission sublease space that Salesforce had on the market. That's over 300,000 feet. So with that backdrop, I'd say we are encouraged about what we're seeing in terms of activity and the conversations we're having. Omicron, no doubt, did slow down tour activity, but things are picking up in Q1 already.

Okay, thanks, Rob. That's helpful. The second question is just going to the guidance for occupancy. If you just look at the range, midpoint is a slight drop in occupancy this year. You talked about the San Diego move out. is one factor. I guess, is there a way to just give us a feel for how you're thinking about the least number in your portfolio, meaning that should we assume that you have more confidence in the least rate growing this year by some magnitude, even if the actual in-place occupancy doesn't?

Let me try to address that in two ways. One, let me just talk about the last quarter. And this is, I think, really interesting. It goes back to some of the comments I made earlier. At the end of the last quarter, and this is really from Thanksgiving through the end of December, we signed three what I think are significant leases. We signed 80,000 feet with a media company in Southern California. We signed a 71,000 square foot lease with a major technology company. we signed a 38,000-square-foot lease with a life science company in the Bay Area, and we signed our first two leases in Austin at above our underwriting. And that literally, Nick, is from November to December in the midst of Omicron. I'm encouraged that that momentum has continued. I'm encouraged by the amount of activity that we have across our platform right now, including Austin, where it seems like every week we're getting... We're getting RFPs and requests for information on the building, but we have a fairly significant amount of leasing activity, proposals, that sort of thing that we're working on right now and have been working on in January. So I do think as momentum picks up, as some of the factors I addressed earlier take hold, we'll see that pick up throughout the year. And then, of course, there's always the lag between a lease Sorry, the last thing I'd say is, you know, there's that lag between a lease being executed and then physical occupancy of the space.

Okay, thank you.

Thanks, Nick. Thank you, Nick. Our next question comes from John Kim from BMO Capital Markets. John, your line is now open.

Thank you. I'm looking at your lease explorations for 22, and you have a footnote that you have 215,000 square feet that have already been addressed through lease assigned. Are any of those going to be occupied this year and contributing to FFO, or are those all 2023 commencement dates?

Yes. The roughly 200,000 that's leased but not yet occupied will likely come in towards the end of the year. the fourth quarter.

Okay.

That's helpful. John, you mentioned one of your objectives for the year is to look for unique external growth opportunities. I wanted to ask if you could elaborate on that, whether that means complex development opportunities or when you mention unique, is it a new market, new asset type, just any comment that you could provide?

You know, we always look at sudden calls before we look at a variety of different markets. We don't have our sights on anything specific right now. We did grow into Austin, as we all know, this last year. We're very pleased with what we acquired. We've been very active in looking for sort of the next act in Austin. I think we'll have something to address with all of you within the next quarter or two. if you take a look at what our pattern was, and I referenced the comments between, uh, San Francisco and, uh, Seattle and, and, uh, uh, Hollywood and so forth. Uh, typically what we did was we went in and we bought a building, maybe we bought a couple more buildings, uh, and, uh, both buildings where we could add value, but where we had the, where we had the scale to support the organization. of people that will allow us to grow the enterprise and what you should uh what you'll be seeing with kilroy is a similar pattern for austin we've made some big moves with regard to the people that we're going to have in that market we'll be announcing more on that in the next quarter will be a development company there as we are in all of our other markets and i think you'll probably see our next act there be a development opportunity We like that market a lot. All the growth and support that we love is in full display there. So we're looking at a lot of opportunities in that market, and I think that's where our next announcement will probably come.

Got it. Thanks for the call, Eric.

You're welcome. Thank you, John. Our next question comes from Manny Corkman from Citi. Manny, your line is now open.

Hey, it's Michael Billerman here with Manny. John, I wonder if you can just step back a little bit and just think about sort of capital-raising plans as you move forward with sort of sights on additional external growth. And, you know, you think back to the last two years, you know, that February 2020 period well-timed offering at $86 gave you $500 million in liquidity. And then over the course of the pandemic, you, um, use the asset sale market to produce even more liquidity, which has allowed you to do a number of the developments and acquisitions that you've talked about. So I'm curious how going forward, you think about your capital raising plans? I know Hutch is now around the table. Hi, Hutch. It's good to see you there. Has that changed at all, I guess, as you look at the capital markets now that you've put someone in place as sort of in that seat IR in capital markets? Has your sort of thinking evolved around capital raising and how you want to execute it, whether it will be more, you know, sort of self-funding or whether you think about raising leverage, whether you think about raising more equity, just how your thoughts have changed?

Well, yeah, those are all good points, Michael, and hello and happy New Year. We are happy to have Hutch Board to give you a great addition. It certainly provides a lot of additional character to the organization. You know, we're not interested in selling stock at the share price that we have today. We do think we're going to see a recovery in share prices as the back-to-work accelerates in this COVID era. starts to diminish in people's minds. All signs seem to indicate that those things are going to be happening, but I don't see selling stock. In terms of leverage, I'm not a big leverage guy, as you know. We've forecasted $300 to $500 million of asset sales. I think that that's eminently doable. We always look at what product that might qualify for that, either where it's non-strategic or where we may not be able to add a lot more valuable value, sort of like we came to the conclusion for the exchange. So we're going to stay in a very conservative leverage position. We're going to be very prudent with regard to any equity that we issue in the future. And I think there's plenty of ways to move forward with what our funding requirements will be. So more to come.

And then John, how do you, um, I guess putting in place, uh, for the first time, uh, followed you left 20 years, you haven't had a proper capital markets IR sort of position. It was always sort of wrapped up with the CFO and the treasurer. What led you to sort of bring that into the fold today? And what do you expect to get out of it over the next 12 months?

Yeah, that's a good question too. We've been debating this for some period of time. Our enterprise is grown. We recognize that there are a lot more investors out in the REIT space. Some of them are dedicated. Some of them are not. We think a lot of the analysts have a lot more to do than they used to. They're covering a lot more companies. We obviously have greater geographic reach now. And so that generally means that there's increased communication requirements. And by having Hutch, I think we end up with an individual that not only knows the industry very well, knows the markets very well, knows many of the investors extremely well, but is a great communicator. And I think what we can do or what we intend to do is to be in front of people more explaining our story and making sure that people have a complete understanding of the things we're doing. We're pretty excited about all the opportunities we have. some of which we can't really talk about on these calls, and I think Hutch will be a great ambassador for COA. Great. See you next month in Florida. Yeah, okay, great. Well, thank you.

Thank you, Manny. Our next question comes from Steve Sacqua from Evercore ISI. Steve, your line is now open.

Yeah, thanks. Good morning out there. John, I guess first question, San Francisco's certainly been probably the slowest large city to get back to the office, and crime and homelessness have certainly become a bigger problem. I'm just curious the discussions that you're having with city officials to improve quality of life there in order to make the RTO process more amenable to people.

Well, I figured somebody would ask this question, and you know I always have an opinion about politics and politicians and so forth. I think we're making progress, Steve. It sometimes looks slow, but if we take a look at the root cause of a lot of this stuff, it's both in Los Angeles and in San Francisco, and it's prevalent in some of the other big cities in the country in which we don't operate. We have district attorneys that came in, uh, talking about, uh, reform. And what they have done in the case of San Francisco with Chessa Bodine. And in the case of Los Angeles with George Gascon, who by the way, happened to previously be the district attorney for the San Francisco. So in both cases, we have people that are not enforcing the laws. We have people that are allowing there to be these smash and grab things where you can go in and steal under $900, and they won't prosecute you, so the stores don't even try to prevent it. It's just created a terrible situation. And we have the sale of drugs and the use of drugs, as well as certain other things that are illegal, happening on the streets. in a number of areas of both those fine cities and people are fed up. So you have to have folks that, that, uh, unite together to fight these people. And there are recall campaigns for both of these district attorneys, both Chester Bodine in San Francisco and George Gascon in Los Angeles. And it is a massive coalition of homeowners. small business people, larger businesses, existing politicians, former members of their staff, the sheriff in the case, the sheriff building the wave in the case of Los Angeles, and a number of city council people, all of whom have come out against these characters. So we have a recall campaign in both cases. Kilroy is involved in that, as are many of our peers, as are many others from other businesses, homeowner groups, etc. And we're going to clean this up. We're going to throw these bums out. At least that's what we hope to happen. So I think the thing that's really very, very positive is that this isn't a Democratic effort or a Republican effort or an independent effort. It is an effort by a broad coalition of people who want lawfulness, who want the laws to be enforced. And, um, I'm convinced these two will be thrown out and if they're not thrown out now, they'll be thrown out, uh, in the general election. When it comes up, the recall is qualified in San Francisco. Um, uh, the, uh, the, uh, election will be in June. Uh, the, the job approval rating for Chester Bodine is under, uh, is he has, he has job approval. a negative of 67% the last time I looked. Gascon down in Los Angeles is in a very similar situation. So market forces are dealing with this. It's not as efficient as we'd like. We are seeing in San Francisco and in LA an improvement in the homeless situation in many communities, but it needs to go further. That's kind of what's happening. I'm spending a fair amount of time on this, as are my counterparts and some of the other public real estate companies and private real estate companies, but I have to say this is a very broad coalition of business, homeowners, in some cases religious groups. It's just people are fed up.

I appreciate that kind of long answer, John. I just wonder maybe if you or Rob could just comment on Given the current situation today, to what extent is that impacting the leasing discussions that you're having? There seems to be promise down the road, but if some of these things don't really get cleaned up until the middle of the year, that just might slow the pace of leasing until the second half or possibly in the next year. Do you just worry that it delays the recovery on the leasing front in downtown San Francisco?

Yeah, well, let me give you a couple of points and then Rob will fill it in. I'm going to go between the two cities. The Jardin, which is our new 20-some-story luxury apartment building, which is part of the Netflix campus we call Online in Hollywood. We projected that to be at 20% occupancy by the end of this year. It came on stream mid-year. It's now at 85%, the highest rents ever. And it's right in the thick of all that. So I'm not saying it doesn't influence leasing, but notwithstanding that, we're making good progress. Rob, would you talk to the bigger point specifically to San Francisco for Steve?

Sure, Steve. We are seeing momentum picking up in the leasing front, as I mentioned earlier. Sephora and Yelp subleasing at our 350 mission space. Those are two totaling 300,000-foot deals. The Chime deal at 101 California happening at the end of last year. No doubt the question you raised and John's answer are very serious matters and considerations, but thus far it hasn't slowed deal momentum. In fact, I think on the last investor call we had with you, you had asked about Autodesk and, you know, their announcement in January of this year that they were vacating 117,000 square feet at 300 Mission. You know, apparently right now that space is fully committed to another tenant. So that's 100,000 feet that's in play literally, you know, two to three weeks after a tenant announces they're not going to be occupying the space. So, We're definitely not out of the woods, but it's feeling like momentum is picking up. And again, speaking with our competitors that have view space, quality space, top floor space on the bay, they're actually starting to talk in proposals at 10% to 20% over pre-COVID rates for that trophy quality space. So in a very tight segment of the San Francisco market, I think it's – pretty encouraging. If you're in a Class B, C situation where you don't have the amenities, you don't have the common areas, that space is not moving. Or if you have a lot of second generation space, it's not moving. Tenants are looking for plug and play, and they're looking for quality.

Great. And then just one cleanup item for Michelle. Thanks for all the detail on the guidance. I guess the one number that I didn't hear was your expectation for straight line rent and FAS 141 income within the guidance for 22? Do you have a range for that?

Yeah, I think for straight line rent, it'll be somewhere between 40 to 50 million. And I think on FAS 141, it shouldn't be too dissimilar to our 2021 range.

Great. That's it for me. Thanks.

Thank you, Steve. Our next question comes from Jamie Feldman from Bank of America. Jamie, your line is now open.

Great. Thanks for taking my question. You know, just listening to the comments on the call and hearing how tenants want new high amenity, you know, whether it's new development or redeveloped, I'd like to get your thoughts on kind of, you know, assuming we make it past COVID here and things do reopen, what do you think the development cycle looks like across your markets? And do you think there's going to be, it could be even, you know, more opportunities than in the past, given tenants just want new unique buildings? Just trying to kind of get your thoughts on what may be in store. And I know Kilroy has always kind of been ahead of the curve on those types of assets. So we'd love to get your thoughts.

Well, Jamie, it's a little too early to make those kinds of predictions because there has been such volatility and we've had the reversals with the various variations of COVID and so forth. I think what's encouraging now is people are really stepping up and making some big commitments on significant space. I believe that that bodes well for us given our development prowess and some of the land positions we have and whatnot. I think we'll see a continued desire to be in the, they don't necessarily have to be brand new buildings, but they have to be buildings that have location, the physicality, the amenities and so forth that people want. So it could be converged and so forth. But we're seeing a lot of pressure in our markets, whether it's in the Bay Area, whether it's in San Diego, has two good examples of the, and we talked about this before, of the competition between life science and technology. They want the same kind of building and locations, and they have the same need for amenities to attract and retain. So if you think about our project down at Oyster Point. We continue to have tech interested in it. We have life science interested in it. We have one of the largest entitled properties, I think, in the state with regard to what we can deliver there. We think we're in a really great position. It's a perfect environment for outdoors and so forth. And so I think there's going to continue to be a trend of having space that people can control and where they have those outdoor amenities and so forth, whether they're vertically or whether they're horizontal, but where they can be assured that they have the environment that works for their purposes. We hear a lot about wellness now, and you've probably read, there's been articles, including some that were out this morning, about how companies are so focused now about wellness. Well, Kilroy owns more well buildings than anybody in the world except for the United States government. There's nobody that's even second, close second. So we saw that trend. And what we're seeing now is it's sustainability, it's wellness, it's greater ceiling height, it's all these things. And if you are an owner of a building where you don't have that stuff, you should be really concerned. And so the being obsolete in the office space is something I've been talking about for 10 years, and it's accelerating at a significant rate now. So I do think it will translate into more modern space being built because we'll see a bifurcation, buildings that work and buildings that don't work. And if they don't work, they just don't work. Some can be revised. Many cannot. So I think you will see more development.

And when you think, that's very helpful, when you think about your markets, are there some that you think have more commodity or more obsolete space than others?

Well, I think of, you know, you've not seen us buy one building north of Market in the 12 years we've been in San Francisco. You've not seen us do that. You've seen us appear ourselves more towards the not as tall buildings with much higher ceiling heights and all the amenities that we've talked about over the years. I do think the area in central Soma where the flower Mart is and where others have projects will become the next big thing in San Francisco. I'm by no means predicting that those projects are warranted right now, because I think we need to get through this over the next year or two. for the dust to settle a little bit in San Francisco. But we're already having discussions. You know, we have a building that we're going to build in Santa Monica that we just got approved. It's little. It's 150,000, 175,000 feet. It's actually two or three buildings. We're not even marketing it. We haven't told many people about it. And we already have three or four people that want it. And they're all tenants that are in older office buildings in that area. They want to be in the area. They just want to be in the new modern stuff. I think we're going to see this. I think we're going to see that in Austin as well. Austin obviously has a lot of folks who have been moving into it. It has some good buildings. It has a lot of older buildings. I think there's going to be an opportunity there to make the bigger play. And I think you're going to see it nationally. I mean, if you think about what are the buildings releasing in New York? I was just back there last week and I was going through Hudson Yards and one Vanderbilt and all the rest. It seems to me that you know, if people are voting there to be in the modern latest and greatest buildings, because they want to attract and retain their most important, uh, you know, asset, which is their people.

All right. Thank you for that. And if I could just ask a followup on San Francisco, um, it looks like your percent lease declined to 93, nine from 96, six this quarter. You've got next year about 3.5% of your revenues expire in San Francisco. I just want to get your thoughts on what seems to be kind of a deterioration in the percent lease there and then how comfortable are you with the expirations coming next year given market conditions?

Yeah, Jamie, I can start on the percentage lease in San Francisco. I think in the fourth quarter that declined because there was a tenant that terminated its lease early. So that contributed to some of the one-time income that we picked up. But that was one specific tenant related to credit.

And we're in renewal. That won't go into work.

Okay.

Okay, and then the 23 expirations, I know it's a ways out, but, you know, any discussions already of potential move outs or nothing to report just yet?

Nothing on move outs.

Go ahead, Rob.

Go ahead, Michelle. Go ahead.

I was just going to say the 23 expirations, the largest one is related to the West 8th acquisition in Seattle. And like I mentioned in my comments, it's too soon to tell whether or not they will renew or stay. But we did underwrite both scenarios, and we're comfortable with both.

Sorry, I was focusing specifically on CBD San Francisco. It looks like you have, I think, 3.5% of your revenues in 23 expire in San Francisco.

Yeah, there wasn't... Anything that's large, I think it's all 25 to 50,000 square footers. But Rob, I know you and the team have been working to early renew.

Yeah, we have discussions going on, Jamie, on a good portion of that, 23. OK, great.

All right, thank you for the color.

Thank you, Jamie. Our next question comes from Blaine Heck of Wells Fargo. Blaine, your line is now open.

Great, thanks. Good morning out there. Maybe for John or Rob, it's great to hear that discussions seem very positive with your tenants, but I wanted to see if you could talk specifically about lease negotiations and any differences you might be seeing in your lease contracts relative to what was being negotiated and agreed on prior to the pandemic. Are there additional expansion or contraction clauses, any additional optionality on early terminations or extensions, or even differences in the lease term that tenants are willing to agree to?

Hi, Blaine. This is Rob. It's interesting. We're not seeing much discussion or change in terms of things like contraction or terminations. typically avoid those in our leases and are known for that. And I think, especially if you have ground up development, that's just not a, you know, wise path to go down. And I think others, other owners feel that way as well. Um, it's interesting in certain discussions we're having timing is probably the most important point that's raised by the tenant, meaning they want to be in their space and they want to be in it soon. Um, we have a deal we're working on now where, uh, We're using our development construction team to really help expedite permitting and that sort of thing so this tenant can be in place by September. The deal is not signed yet, but that's the focal point. It's not so much what's the rent or what's my term. I think the other component that comes up, particularly if you have a standalone building, is, okay, if I lease in your building, how do I grow? Where do I grow? If I outgrow that building, if I take the whole thing, What do you have around me where I can expand? And that trend started a little bit in 2019, but it seems to be popping up in various, again, depending on the size of the space and the tenant you're talking to. The tenant improvement, because of cost escalation, that sort of thing, the tenant improvement discussion is really one component of an overall negotiation that's going to be driven by, okay, then what's the corresponding rent? you know, for that sort of capital investment. And luckily in the markets we're in, we have the ability to, you know, have our rents correspond to or exceed what the price increases we forecast are.

Okay, great. That's a full color. John, can you just talk about the dispositions you guys have targeted and whether there's any color you can give us on which properties they are or whether there are any common themes like selling out of a particular submarket or selling lower quality assets. And then any guideposts around pricing would be helpful as well.

Yeah, I'm not going to tell you which buildings, but there has always been a theme with Kilroy, and that is if you would be non-strategic, then by definition, it's a candidate. And in some cases, we have uh said okay we really can't add value for a building that is fabulous and otherwise strategic and that would be at that extreme would be the exchange which we sold last year um we regularly go through uh you know the portfolio and determine which assets we think are candidates and elliot can speak to that process but he's not going to speak to the specific assets we don't like to tell people what assets of we're thinking about selling until we've made a decision to sell them because you can imagine impacts to relationships impacts our, uh, our own student body and so forth. Um, but, uh, we, we, Elliot, I don't know what you want to add to that. I mean, it's in terms of, uh, of, uh, guidelines on pricing. I mean, obviously, uh, We can't, until we determine which asset it's going to be, we can't really talk about pricing, but pricing tends to be pretty strong in all of our markets. Kelly, do you want to add any color to that?

Not much more to add beyond that. We are looking at things across several markets, so there's nothing particularly, you're not going to see us wholesale get out of any one market or not. It's just sort of selectively looking at things that make sense for the reasons John outlined.

Yeah, if you look at that little Saver Springs project that we sold out on the 15, it was a property that was a tilted building. It was nice, but it wasn't really the kind of building that we specialized in anymore. We didn't see how it added much to us. The people that bought it, I'm sure, are going to do well with it. But it's a smaller asset, but a good property. example of something that just wasn't really any longer in Kilroy's wheelhouse.

Okay, great. That's helpful. One more quick one, if I can. Can you guys give an update on your estimated mark-to-market for the entire portfolio and maybe even on a market-by-market basis, if you have that detail?

Yeah. Hi, Blaine. So, similar to the third quarter, we're estimating The portfolio is roughly 15% below market. And by market, San Diego is about 20% below market. LA is about 15%. And San Francisco and Seattle are about 10% to 15% below market.

Great. Thank you all. Thank you.

Our next question comes from Craig Melman from KeyBank Capital Markets. Craig, your line is now open.

Hey, everyone. Just a couple quick ones here. Just, Michelle, maybe following up on the disposition question, could you give us a sense that 12 cent drag from dispos, what would that be either on like a timing or cadence or, you know, if you have an annualized number of what that 12 cents would be?

Yeah, we assume the midpoint of that in the mid-year.

Okay. And that includes Saber Springs also?

Yeah, and Saber Springs, we sold towards the middle of December. So that would have, it was roughly a two cent impact for 2022. Thank you on that. Then just,

The last one for me, as we think about occupancy, I know you mentioned the 145-down-square-foot tenant that vacated. So should we think about it that one Q kind of dips to the midpoint of your guidance and then kind of stays there as the $500,000 or so kind of trickles through the portfolio? Or do you have any other smaller known move-outs that kind of add up that will impact given quarters?

Yeah, I think you're right. The first quarter will dip due to the San Diego expiration. And then we have some development project coming online in the third quarter that I mentioned with 333 Dexter. And then some of the small move outs that I mentioned in LA will be a dip again. Also further impacted by 2100 Kettner coming online.

Okay, perfect. Thank you.

Thank you. Our next question comes from Vikram Malhotra from Mizuho. Vikram, your line is now open.

Good morning. Thanks for taking the question. I just wanted to go back to sort of the relative markets and your positioning. You talked about the quality divide quite a bit. through all the markets, but just two specific questions. One, can you talk about relative pricing power in each of your office locations? And related to that, is there something different about sort of the San Francisco city slash peninsula recovery this cycle versus prior cycles in your mind?

Hi, Vikram. This is Rob. Let me touch on the pricing power question first. Clearly, probably the three strongest submarkets for pricing power for us are the Bellevue, Seattle market, the Oyster Point life science market, where John was mentioning our 50-acre site, 3 million square feet. And then lastly would be, actually, I shouldn't exclude Austin either. We have pricing power there. And then lastly, San Diego, because of the combination of life science and technology in that market. So it's really San Diego, Austin, Oyster Point in the Bay Area, and the Seattle Bellevue market. And then what was the second part of your question?

Yeah, just on San Francisco. I mean, it's historically bounced back faster and quicker than, I guess, other markets. Is there something different in your minds about specifically San Francisco, the recovery this time?

Yeah, you're right that it's bounced back frequently in other downturns. I think the crux of the – there's two points. I think one is that the city, more than any city in the country we've said before, was shut down more so than other cities and longer. That's behind us now. Secondly, I think it's really been impacted by technology employers not really – you know, pushing their employees to come back to work or putting more formalized plans in place. And as I said earlier, I think now that they're announcing plans and, you know, shortening the timeframe for people to come back, that that will improve. But what's interesting, if you compare Silicon Valley, Silicon Valley and San Francisco have often worked in tandem. So when you have large headquarter expansions in Silicon Valley, there's usually a subsequent spillover into San Francisco just because there's so many employees that work in the city. In San Francisco, this cycle has lagged, but I think it's because of the reason I mentioned earlier, you know, being shut down and employers not really bringing people back in. But, you know, the last piece is anecdotal, but if you look at every bar and restaurant in San Francisco, they're jam-packed and full. So I kind of don't get why people can go out eating and drinking, but they can't. be in the office.

Fair enough. Just maybe turning to Austin, you referenced potentially some opportunities in the next one or two quarters on the development side. Can you maybe remind us of, are there specific submarkets you're exploring within Austin? And maybe just remind us of the grand sort of vision over there in terms of how large would you want your portfolio over there to be? John, you want me to handle that?

Kelly, do you want to take that one? Yeah. Sure. So, Vikram, there's no magic number for how large we want to be. We want to do deals that we think are smart deals. And if that means we're 2 million square feet, great. If that means we're 3 million square feet, that's great, too. So we're not going to anchor ourselves to a particular number. As far as the parts of the market that we're focused on, Obviously, the CBD, where Indeed Tower is, and the surrounding areas around the CBD. And then we also like the area in and around the domain, as well as some others.

Okay, great. And sorry, just one last clarification, Michelle. Maybe the mark-to-market you referenced, I just want to confirm that's a cash mark-to-market?

That's correct, yes.

Okay, thank you.

Thank you, Vikram. Our next question comes from Michael Carroll of RBC Capital Markets. Michael, your line is now open.

Yeah, thanks. Can you guys give us some color on your life science views in San Diego? I know a number of your projects are just north of the traditional core markets and You're indicating that the market is starting to move upwards, given the tight market overall. I mean, how quickly is this migration occurring, and how attractive are these submarkets today?

You want to take that, Rob? Sure, I can start, but pitch in, John. So, you know, as we've said before, Torrey Pines was the initial, you know, life science in San Diego, and that quickly filled up. That's traditionally been the basis of life science. The UTC submarket sprouted relatively recently, and because it's such an attractive location in terms of housing as well as just access and amenities, it became attractive to life science because it was the next natural geographic spot to locate. But it also became very attractive to technology. And I would say that to your question, the migration is happening very quickly. We have seen a lot of life sciences. We've mentioned in our Del Mar Heights and Del Mar One Paseo office campus. And that trend is continuing. And as John has mentioned before, you're seeing it out into the I-56, I-15 corridor because On the West Coast, you have really the Oyster Point location as a life science hub, and you've got San Diego as a life science hub, and both are thriving. So I think you're going to see a lot of expansions and new moves into submarkets within San Diego where there's housing, where there's amenities, and where's the type of project that these companies want. I think the last thing I'd say is that tech is really adding pressure to life science to act more quickly. You know, life science typically has been slower to act than other companies leasing space just by nature of their character.

Yeah, this is John. Del Mar has always been a life science market. There just hasn't been any space in Del Mar, Carmel Valley it's also called. That's where our office is. That's where One Paseo is. We announced last quarter, I think it was, that we'd sign leases for 300,000 feet of life science down in San Diego. Most of that's in Del Mar, taking buildings that work very well for conversion from office space to life science. And we moved the rents up. I think they were double or whatever. And now that's pushing out. One of the tenants that's here in Del Mar is moving up. T. To the 56 and a new half million square foot building, etc, construction are Santa Fe summits right after that. T. If you look at the demographics of where people live, where they want to be and so forth. We're sort of in the sweet spot and the crop said traditionally it was Torrey Pines and a good UTC then it jumped the freeway a little bit for secondary locations. where people really want to have when they want to have the quality of location, the quality of product, the, the, the, the campus, et cetera, it's got to push up, uh, east now. And that's what's happening.

Okay. Grand. And with regard to Santa Fe summit, I know this is a near term start. Um, in the first half of this year, I believe you guys are targeting. Can you talk a little bit about that? What are you waiting for to break ground? Are you looking for some pre-leasing, some entitlements, or just getting things ready to break ground right now?

Yeah, we're ready. We're negotiating the contract. That'll be under construction, I think, next quarter. We have the permits in hand. We'll start with a guaranteed max price from the contractor. all the architecture is done and permitted. So we're full steam ahead.

And are the underwritten rents similar to the course on markets, just given what you're kind of indicating that people are moving north?

Well, I'm not going to get into what the rents are and give out that information to brokers or whatever, but let's just say that It is a better value than what leases are going for in the core of Tory and UTC, but it is also going to produce a much better yield than developers are getting there.

Okay, great. Thanks, John.

You're welcome.

Thank you, Michael. Our next question comes from Caitlin Burrows from Goldman Sachs. Caitlin, your line is now open.

Hi, good morning there. Maybe just following up on the point from earlier that some office buildings won't make it, when you think about the vacancy in lower quality properties in San Francisco or otherwise, what do you think ultimately happens to this product? Does it remain office with low rents? Does it get converted or does it get redeveloped? And if so, do you think that's something Kilroy would be interested in participating in?

Yeah, I'm not going to say this, John. I'm not going to say never, because I've learned that's a bad thing to say. But a lot of the stuff that's over, for example, the north side of market, a lot of that is just dark, smaller floor plate, lower ceiling height, space in an area that isn't always the best to monetize. And I think, you know, does it become residential? I think that's probably what will happen, or does it become some kind of boutique office space with smaller tenants? You know, if that could be the case, uh, I don't really worry about it too much because we're not actively seeking to be there. Um, but, uh, I, I do think there is a real, uh, bifurcation, and I've been talking about this for 10 years. And now, you know, what's funny is for the last 10 years, I've been talking about, not for the entirety of the 10 years, some of it's newer. I've been talking about the obsolescence of office space in the country, what the modern office building is going to look like, what kind of amenities and so forth it's going to have, sustainability, wellness. And, you know, all these things are now we're hearing about like they just came up. I mean, some people have been talking about them for sure. And a lot of people are just now sort of discovering them. But these trends have been going on. And if you just look at them, if there are fewer and fewer people, I mean, ultimately, there's going to be a discussion, and they're starting to be right now, about electric vehicles versus gasoline-powered vehicles, right? And so people are making big bets on electricity because they're saying that, hey, gasoline is killing the environment. So where do you want to make your bet? That's not saying that gasoline-powered cars are going away anytime soon. but they are diminishing and there is the political and public, uh, uh, kind of policies that are encouraging that. And if you think back down and taking that same sort of method methodology or, or thinking to office space, I don't want to invest in things that are going to go bad. I want to invest in things that are going to get better. I want to invest in the markets where there are, where there is the energy, and the creativity and the multiplication of employers and so forth, and therefore greater demand, greater rents. And I want to have the kind of assets that people want to be in. And I want to have the kind of team that allow people to feel comfortable that will grow with them and will be able to deal with their growth and scalability and so forth. And to me, that's a virtuous cycle to get involved And we might get involved in something here or there that is out of that description. But by and large, I think if you start looking at some of these older buildings, unless you really buy them at a big discount and you have a plan to convert them to housing or something, it would not be interesting to me.

Got it. And then maybe just a question on lease execution volumes. As you mentioned, a lot of the trends intent and demand do seem to be towards the higher quality, newer, highly amenitized buildings. But it does look like Kilroy's execution volume is still below the 2017 and 18 average levels. So just wondering, is there something that's causing that? And could you go through your expectation for how and when it could recover?

Rob, that's you. Yeah. So Caitlin, as I indicated earlier, our activity for the first quarter so far, January, is picking off the momentum from the last month of 21. So I feel very good about where we are and what's ahead of us. 2017 and 2018 were really extraordinary years. 2017, 18, 19 were really the ramp up to a peak in all of our markets. And then, unfortunately, the pandemic hit us, which virtually put a stop to leasing in 2020. We slowly picked up out of 21, and I think we finished very, you know, solidly in the fourth quarter. And I expect more activity and volume, as I've said, for a variety of reasons in different markets. San Francisco bringing people back to work. Life science and technology in the San Diego markets competing for space. Austin, because new companies continue, you know, the two companies I announced that we sound leases with are moving moving into Austin, have never been there before. So we're seeing continued activity there. Seattle and Bellevue continue to remain very attractive. I would say that, as an example, Bellevue now has, because the market in Bellevue is so tight, you're seeing tenants starting to look in the CBD of Seattle. So I think a lot of fundamental strength is coming throughout our markets. It's just going to take time throughout this year for that to manifest itself in leases.

Got it. Okay. Thank you.

Thank you, Caitlin. That concludes today's Q&A session. I'll hand back over to Michelle Ngo for any closing remarks.

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