Kilroy Realty Corporation

Good afternoon and thank you for attending today's Kilroy Realty Corporation first quarter 2023 earnings conference call. My name is Donyell and I will be the moderator for today's call. All lines will be on mute on the presentation portion of the call with an opportunity for questions and answers at the end. If you would like to ask a question, please press star followed by one on your telephone keypad. It is now my pleasure to hand the conference over to our host, Bill Hutchison, Senior Vice President of Investor Relations and Capital Markets. Bill, you may now proceed.

Thank you. Good morning, everyone. Thank you for joining us. On the call with me today are John Kilroy, our Chairman and CEO, Justin Smart, our President, Rob Prott, our Chief Leasing Officer and Senior Advisor to the Chairman, and Elliot Trencher, our CIO and CFO. 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 our first quarter highlights. And then Elliot will discuss our financial results and provide you with our updated guidance. Then we'll be happy to take your questions. John?

Thank you, Bill. Hello, everyone, and thanks for joining us. First and foremost, while we're seeing strong signs in the economy and remain optimistic, we would like to acknowledge that we are still facing cyclical and secular headwinds. The macro environment today, I think I defined as it just lacks certainty. Sentiment is challenged, and financial stocks such as Silicon Valley Bank and the crisis that was created related thereto continue to dominate headlines in many areas. From a real estate perspective, we have seen the implications of the current economic backdrop translate into near-term obstacles. There has been a reduction of liquidity in the investment sales market, downward pressure on leasing fundamentals as tenants delay space requirement decisions, and a pullback in financing and investment activity within the banking and venture capital community. However, despite these macroeconomic challenges, we are proud to announce that we delivered a strong quarter and record FFO per share. Elliot will go through the quarter in more detail when he gets to his remarks. Shifting to our markets, we would like to highlight encouraging trends and what we are seeing with our boots on the ground in each of our regions. As we discussed on prior calls, physical occupancy in our portfolio continues to trend up and the share of job postings that are remote has been trending down. Austin and San Diego continue to lead the way with respect to physical occupancy with over 70% at quarter end. These markets continue to edge closer to pre-pandemic levels. San Francisco a region which admittedly has been lagging in regards to return to office, saw its highest quarterly increase of over 6% in physical occupancy since the start of the pandemic. The widespread return to office announcements from top tech firms have been translated to noticeable increases in physical occupancy in our San Francisco portfolio, and we expect this trend to continue. Los Angeles and Seattle both saw positive physical occupancy trends during the quarter, increasing to approximately 50% and 40% respectively. This reflects another encouraging update for our markets, and we anticipate this trend to accelerate as more return-to-office mandates are implemented. The antidotes back up our portfolio data. Recently, JP Morgan told senior bankers to be in the office five days a week, Amazon three-day-a-week policy is set to begin next month, and others are following suit. Many companies are realizing the inefficiencies of remote work and are starting to demand change. As Amazon CEO Andy Jassy wrote in his recent shareholder letter, we've become convinced that collaborating and inventing is easier and more effective when we're working together and learning from one another. And I can tell you at Kilroy, we feel exactly the same way. The actions of these companies and others across a cross-section of business sectors, including Apple, Disney, Starbucks, Deloitte, Capital One, and many others, highlight the long-term importance of the office in increasing productivity and enhancing collaboration and culture. As return to office continues and companies have real data to support the power of in-person work, our portfolio is well positioned to capitalize on the resurgence of demand and flight to quality dynamic. As evidence, since the end of the fourth quarter, we've signed approximately 338,000 square feet of leases with an average term of approximately five years. In many of those, we had no capex. In Austin, we signed another lease at Indy Tower for 20,000 square feet with a national wealth management firm, bringing our occupancy to 74%. We have had great touring activity in the building and demand for space in Indeed Tower has increased over the last couple of quarters, which we expect to turn into good news. We have also executed notable leases across our Bay Area and San Diego portfolios. In San Diego, we leased a 65,000 square foot new lease with MediaTek USA and a 25,000 square foot renewal with Intrepid Studios. In the Bay Area, we leased a 50,000 square foot new lease with Reddit and a 65,000 square foot renew with 23andMe. In addition, innovation continues to happen in our markets. The ecosystems on the West Coast took many decades to build and continue to have all the ingredients for success. Engineering, computer science, and medical students are attracted to world-class universities like Stanford, Cal Berkeley, and UCSD. The most prestigious venture capital funds are headquartered in Menlo Park, and the biggest technology companies in the world are based in San Francisco and Silicon Valley. This recipe results in the formation of new, innovative companies such as fintech, social media, self-driving cars, and more recently, artificial intelligence. The Bay Area in particular has been the birthplace of many of these businesses, and AI is no exception. as over 40% of AI companies are based in the region. While it's still early days in this translating to demand for office, the bigger takeaway is innovative companies still want to be in the city and San Francisco Bay Area. Moving on to life science, there continues to be long-term themes that have prevailed which bear mentioning. 2013 marked the beginning of a 10-year run which radically shaped life science as we see it today. The critical driving factors that define this burgeoning industry included aging population, improved FDA approval processes, rapid M&A activity, and the availability of funding to catalyze research and development activities. After record years of venture capital funding in 2021 and 2022, these funds still maintain large levels of dry powder, with some deals getting done, but not all at the clip we have recently witnessed. That said, we believe increased capital will eventually be deployed as business conditions improve and will provide a powerful boost to the life science ecosystem. The acceleration of technological advances within the life science space is creating breakthroughs, pushing the frontier of what can be accomplished. Sciences such as gene therapies, mRNA, and immunotherapy are in the midst of rapid change that will redefine the art of what is possible. Also, we believe the convergence of artificial intelligence and technology companies focused in the life science space will move the needle even further. These types of hybrid companies are in their infancy and have yet to fully mature. Gilroy has high conviction in the underlying long-term life science fundamentals and will play the long game as we increase our exposure to the sector. As a reminder, life science will make up more than 20% of our NOI after KOP Phase II delivers, and over time we expect this number to grow to over 30% as we develop and lease future life science projects. Zooming out to our platform and current mentality, we at Kilroy have built a company that is positioned for both offense and defense. This is not accomplished overnight, but it's been a core principle of our strategy spanning across cycles. As we sit here today, Kilroy has one of the strongest balance sheets in our sector, headlined by a moderate leverage profile, robust liquidity, and limited term debt maturities. Our portfolio is young and modern, comprised of high-quality, well-located assets that we believe will prove to be resilient over time. Lastly, the management team at Kilroy is cycle-tested, managing through periods of economic uncertainty, and has a proven ability to take advantage of market conditions as they unfold. We remain opportunistic in our ability to create value for our shareholders as we have done through previous cycles over time. As we think about how to move through the current downturn, I would like to share with you how we have positioned the company in this current environment. In previous downturns, Kilroy has emerged stronger. A case in point, the steps we took during the great financial crisis of 2008-2009 led to a total transformation of the company. We enhanced the quality of our assets and pursued product expansion in new high-growth markets, creating significant value for our shareholders. And we are not done yet. We are focused on the following actions to ensure that we emerge from the current downturn in a place of strength. Maintaining a strong balance sheet and opportunistically evaluating alternative sources of capital to further enhance our already significant liquidity position. Providing certainty to our tenant base in today's environment. Prospective tenants are increasingly evaluating landlord capabilities and financial strength. In essence, tenants want to know that their landlords have the financial capacity to fulfill their needs and obligations while being able to provide an exceptional level of service. Positioning our assets to be top tier choices when the time comes for tenants to making leasing decision is another important focus. If there are 20 choices in the market, or there may be more, we intend to be one of the top three. heightening our focus on driving organizational efficiencies and reducing our capital spend where appropriate, and positioning the company for its next 2010 moment. Periods of change always present opportunities, and we intend to be opportunistic when the time is right. In summary, our strategy is based upon maintaining best-in-class real estate, disciplined capital allocation, a fortress balance sheet, and the team to execute. We have adhered to this principle, rather to this simple but effective approach over multiple cycles, which has given us the ability to play defense on the downside while maintaining the wherewithal to be opportunistic when it makes sense. And lastly, as I'm sure you all saw, last month I announced my retirement effective at the end of the year. 2023 marks my 28th year as CEO of Kilroy Realty and 54th of the company, including its predecessor. I've dedicated my career to Kilroy and I'm pleased to be able to retire with the company having the best portfolio amongst our peers, an impressive capital allocation track record, a solid balance sheet, and very importantly, a deep and talented team. I'm confident that we have the pieces in place to continue executing at the level investors have come to expect from Kilroy, and as a significant shareholder, I'm incredibly invested in the continued success of the company. That completes my remarks, and I'll turn it over to Elliot.

Thank you, John. FFO was $1.22 per share in the first quarter, the highest quarterly FFO in the company's history. This is up roughly 5 cents net from the prior period, mainly due to a full quarter of revenue from Indeed's lease in Austin. Our results included both positive and negative non-recurring items, which more or less offset each other. On the same store basis, the first quarter cash NOI was up an impressive 16%. This includes roughly $12 million of tenant restoration payments tied to two properties. Excluding this non-recurring revenue, same store NOI would have been up about 9%. The strong same store is due to free rent burn off at phase one of KOP in South San Francisco and higher parking income. Gap same store NOI is up roughly 2% after adjusting for the non-recurring items. At the end of the quarter, our stabilized portfolio was roughly 90% occupied and 92% leased. The decrease from the prior quarter was due to previously disclosed move outs, including direct TV's downsizing in El Segundo. Leasing spreads in the quarter were negative 4% on a cash basis, driven by one lease in San Francisco. If we were to exclude this lease, spreads would have been up approximately 8% on a cash basis. Net debt to first quarter annualized EBITDA remained about six times. I want to emphasize that we have no debt maturities until December of 2024 and limited interest rate exposure with over 90% of our debt fixed. As John mentioned in his remarks, our liquidity remains strong at $1.6 billion, which is comprised of $330 million in cash, $170 million in future term loan proceeds, and $1.1 billion of capacity on our line of credit. One modeling note, during the last week of the quarter, we drew down $150 million in term loan proceeds in accordance with the terms of the agreement. So the first quarter interest expense run rate needs to be adjusted if you are trying to use that as a starting point to project the balance of the year. Our capital requirements for the remainder of the year are $325 to $425 million of development spend. Obligations for 2024 include a $425 million debt maturity in December plus any additional development costs. Our net liquidity is robust. but we will not hesitate to enhance it should attractive opportunities present themselves. Before discussing guidance, I wanted to point out some additional disclosure in our supplemental. On pages 14 through 16, we point out the four properties not in the same store pool. Consistent with our longstanding policy, we add properties to the same store pool once they have been in the stabilized portfolio for a full calendar year. So these four properties will all go in at the beginning of 2024. As of the first quarter of 2023, the same store pool represented 93% of our stabilized square footage. Now let's discuss our 2023 guidance. As always, no acquisitions are forecasted, and we continue to expect dispositions to be between zero and 200 million. Our roughly 50,000 square foot life science redevelopment at 4690 Executive Drive in San Diego was fully leased to Sorrento Therapeutics, However, they recently filed for bankruptcy and rejected the lease. As a result, the building is now projected to enter our stabilized portfolio in 2024. We anticipate drawing down the remaining $170 million from our turn loan over the next two quarters. As I previously mentioned, development spend for the remainder of the year is expected to be $325 to $425 million. When factoring in the roughly $75 million of spend in the first quarter, the full year estimate of $400 million to $500 million represents about a 10% decline in spend compared to our original projection. There's no change to our expectations for same-store cash NOI, which is projected at 0% to 2%, or average occupancy, which is projected to be between 86.5% and 88%. We anticipate additional G&A costs of $8 to $14 million from contractual obligations tied to the accelerated vesting of shares in connection with an executive retirement. Outside of this, there is no change to our G&A estimates. In summary, our original FFO guidance for 2023 was $4.40 to $4.60 with a midpoint of $4.50 per share. While most of our underlying assumptions are unchanged, we are updating our range to reflect the one-time G&A cost of approximately 10 cents at the midpoint. This brings our updated range between $4.30 and $4.50 with a midpoint of $4.40. Were it not for the G&A adjustment, our FFO guidance would have been unchanged. To provide further clarity, Guidance implies average quarterly FFO of roughly $1.06 per share for the balance of the year, or $0.16 lower than the first quarter. To bridge the gap on the $0.16, we subtract a net $0.10 due to lower 2023 occupancy, which factors in our move outs and move ins, including our West 8th move out in Seattle, which is effective at the end of April. We then subtract six cents for various other items, most notably the non-recurring G&A costs and higher interest expense from remaining draws on our term loan. In terms of sequencing throughout the year, the second quarter will be higher than the third and fourth quarters given one month of Amazon and the projected timing of drawing down the balance of the term loan. That completes my remarks. Now we will be happy to take your questions. Danielle?

If you would like to ask a question, please press star followed by one on your telephone keypad. If for any reason at all you would like to remove that question, please press star followed by two. Again, to ask a question, please press star one. As a reminder, if you are using a speakerphone, please remember to pick up your handset before asking your question. We will pause here briefly as questions are registered. The first question comes from Nick Uliko of Scotiabank. Please proceed.

Thanks. First question is just maybe you could talk a little bit more about, you know, leasing traction right now in South San Francisco. And, you know, if we should think about for phase two there, Oyster Point, you know, could that be a longer leasing timeframe now? And I guess also from just from a sort of NOI commencement perspective, If you could just remind us, let's say if you got a lease done at some point this year, when would be the earliest you'd start commencing some NOI on that?

Sure, Nick. This is Rob Peratt. Let me give you a backdrop on South San Francisco. First of all, just to remind everyone, we have three buildings, about 863,000 square feet under construction. The buildings were purposely designed for life science, but they can accommodate single users as well as multi-tenant. With the current situation with SVB and just the general economy, decision making has slowed down, no doubt. Deal size has gotten smaller, but right now in the market, there are 36 requirements that total about 2.3 million square feet, and I would say That's off from about 3.7 million square feet prior to some of these negative economic headwinds that we've had. Right now, we expect deal size, as I said, to be smaller. So I think probably an average size right now is about 65,000 feet. Our floors are 44,000 feet. Some of the space that's in the market right now is a single floor is only 20,000 feet. For us, we can accommodate 44,000 feet on one floor or a floor and a half for a larger tenant in the 60,000-foot range. That makes it much more efficient for the tenant. So we've always looked at the project. We never really anticipated that we would lease all three buildings to one single user. We market that way, of course. We go elephant hunting, but this is really going to be a multi-tenant, floor-by-floor, sort of block and tackle game, but there are large tenants in that market and continue to be despite what you may read in the headlines. So the other thing I'd say is that there is more sublease space on the market. Again, that's sort of, and I'm looking at sublease space that's spread between Sierra Point and Oyster Point, and you know Oyster Point is really the main and main of the market. And that subleaf space, again, is characterized, some of it's very usable, but again, it's 18,000 feet, 20,000 feet, no significant contiguous blocks of space in the market. So long story short, things will take longer, but there are deals out there. And even with the VC funding environment, Silicon Valley Bank wasn't the only lender to the venture capital world. There's a lot of private equity including Blackstone and others that have moved into the space. So although funding has slowed down, I think everyone is just, as John has said numerous times on our calls, if you don't have to make a decision today, you won't make it.

With regard though, Nick, this is John speaking, specifically to does it change our stabilization dates, just to remind everybody that there's three buildings, they sort of stagger a little bit but the first building is scheduled to be completed as shell in mid 24 and they sort of roll after that the other three and then it's a year they're out from those dates that we anticipate stabilization pursuant to our performa we don't see anything at this point that changes those i mean obviously we'll update if we do but we think those are probably still pretty good dates

Okay, thanks, John and Rob. Just second question is on, you know, this idea of, you know, maintaining the strong balance sheet, looking at, you know, evaluating some alternative sources of capital. Maybe you just talk a little bit more about what, you know, that could look like and what's going to drive that decision-making. You know, is it, it ends up being a slower leasing process at Coroy Point, you know, for, you know, has you consider, asset sales, just to raise some more liquidity as maybe the NOI gets delayed there, or just how we should think about potential sales, JVs, types of assets you're thinking about, and what would be the reason to do that? Thanks.

Well, as you know, we have a tremendous amount of liquidity and a great balance sheet and very little debt that's coming due. Ellie can give you the specifics. But we're going to remain flexible as we always do. We purposefully built the company to make sure that we had plenty of liquidity and a great balance sheet if we ended up with headwinds, and we do have headwinds. And I've always said that we're going to play offense, but in order to play offense, you've got to be able to play defense. So I think we're really well positioned. We don't feel like we have our backs against the wall on any of that. And as things sort of sort themselves out, we think that there'll be a much better functioning debt market, which will help the buyer market. As you know, last year, we decided not to proceed with some of the disposition activity that we had forecast just because we felt the pricing would be better if we waited. So you might want to cover Elliott's. I mean, in terms of potential sources, there's a lot.

Yeah. Nick, just to add to that, what we were trying to convey is we feel really good about where we are liquidity-wise, but that doesn't mean we're just going to sit here and wait, right? The way that we've gotten to this position is by being opportunistic. We didn't have to raise a term loan last year. We saw what we thought was an attractive opportunity and we pursued it. And that's our mentality this year as well, is that we don't feel compelled to do anything, but as we evaluate our alternatives, if there is something that's appealing, and that could be on the secured side, that could be on the unsecured side, that could be on the sales side or the venture side, if we see something that we think is attractive that helps the long-term situation for the company, we'll pursue it.

Thanks, Ellie. Just one last one. John, I think you outlined very well, and congratulations on the retirement. You outlined the reasons why you decided to retire, but I guess I'm just wondering the consideration to make that announcement before lining up the successor. Maybe you could just outline some of the thinking on that. Thanks.

Yeah, well, you know, at the board level, we talked about this a lot, and the reality is that you can, unless you have a specific individual that you have designated to be internally or externally the person, you can wait. If you're going to go through a process, it's going to get out. It just is going to get out. There's nothing that doesn't get out today. Probably the fastest way to get something around is tell somebody it's a secret. And, you know, so our view is we want to be very transparent. We have some great candidates internally. We may find some great candidates externally. You know, in order for that process to go about efficiently, it means that we want our senior management team to be involved in it and whatnot. And, you know, it's just we came to the conclusion that it was best practices to be transparent. So that's what we did. And we wanted to make sure we had plenty of time to go through the process and whatnot. And, you know, if you've come to know anything about Kilroy, we kind of tell it like it is. And we tell it as early as we think it's appropriate to do so. And once, you know, I've made my decision, basically, it was time to tell people. And, you know, it's always kind of bittersweet. You know, what's a great time to leave? You know, for me, I have a lot of things as I put forth in my letter that I want to do in my life. including sport and whatnot. I got a bunch of grandchildren. I see them about once a year. They all live in different countries. And so, you know, I want to spend some time. And, you know, I think this is a good process.

Thanks, John. Appreciate it.

The next question comes from the line of Georgie Zinkola of Mizuho. Please proceed.

Hi, thank you for taking my question. Could you please walk us through known move outs in the next 12 months? And in terms of your top tenants with expirations in 24 and 25, do you see any early termination risk?

So this is Elliot. We've touched on a few of the top of the known move outs, and we'll highlight the major ones. We've got Amazon. that we've talked about at West 8th that's moving out in the second quarter. We've talked about PAC-12 that's moving out in the Bay Area in the third quarter. And then RIOT, which is still TBD, is a fourth quarter expiration. In 2024, we have two move outs over 100,000 feet, both of which are TBD in terms of how those play out, and we have none in 2025 over 100K.

Great, thank you. And just one more question on Austin. You know, given the high sublet space, do you see any downside risk in terms of early terminations?

Austin, our building is brand new and all the leases that it's either just started or will start when the tenant improvements are done and there's no termination, right? So I don't see any termination risk at all. And I might point out that I didn't in my comments. This is John speaking, by the way. is that we've been exceeding our performer rents quite substantially there. So I think all systems are go for Indeed Tower.

Great. Thank you so much.

Welcome. Thank you. The next question comes from John Kim of BMO. Please proceed.

Thank you. Good morning. And John, congratulations on building a great real estate company. I was wondering if you could discuss how involved you plan to be going forward with Kilroy, if you plan to remain as chairman, and any characteristics you could share as far as your preference for a successor.

Somebody smarter than me. Hi, Barb. I'm always a smart aleck. You know that. So, you know, John, I can't get into the search and all the rest. Some of the candidates might be in this room. And, you know, my whole thing about team and teamwork is pretty transparent, whether it's been in the sailing of a successful enterprise or whether it's in an enterprise like Kilroy. is that one of the benefits you have when you have a strong team that works well together is you can talk about, you know, who might be the next leader, whether it be from the inside or out, and good opinions, and it makes it a stronger process. And, you know, so more to come on that. As regards to my continued involvement, you know, I mean, I'm chairman. I'm going to continue to be on the board and so forth. I'm a big shareholder. I have a big mouth, so I'll probably talk to people here and there. I'll probably get a few inquiries occasionally asking me whether I think this is the right thing or the wrong thing, and, you know, I'm open to all that. But that kind of remains to be seen. I do believe that, you know, we've got a great management team, and I think about, again, back to my sailing analogy. When I was doing all my ocean racing and I was captain of the boat, I was a watch captain. I had another watch captain always listen to what they had to say, but sometimes I overruled them and I would come up on deck and I could tell it made them feel a little bit unedgy because it's kind of hard to have two captains on deck at the same time. And you got to trust people. I think we have a really terrific team of people here that have worked really well together. And it's the ultimate in collaboration. So, you know, I'm available, but I'm pretty confident. You know, a lot of the decisions that get made here, it may ultimately come down sometimes to me, you know, making the final decision. But generally, they're arrived at pretty quickly by mostly consensus.

Okay. To clarify, you're not necessarily going to stay on as chairman?

Well, I'm chairman for now. Do I at some point decide that that's not the right thing or whatever? I don't know. I mean, I haven't gotten there yet. I'm going to do what is in the best interest of Kilroy.

On the Sorrento space, I just wanted to ask if there was anything unique about that build-out that would make it difficult to lease or release quickly, or if something like that is almost ready to move in is attractive to tenants in the marketplace today.

Hi, John. This is Rob Peratt again. So the Sereno space, just to frame it a little bit, is in the UTC submarket. And as you've heard us talk about before, UTC has both technology and life science. And this project in particular was renovated with a life science use in mind. doing some upgrades it was an existing asset so we're doing some upgrades like the lobbies and some of the exterior mechanical systems we haven't gotten control of the space yet but we think it's very marketable and we because we haven't started tis and that sort of thing we can go either way and i think one thing i'd remind you of also is that as you've seen before whether it's our exchange project or others they can play both ways. They can accommodate life science or they can accommodate tech. And tech, frankly, loves the robust systems that life science requires. Great. Thank you.

Thank you. And as a reminder, On behalf of the management team, can we limit ourselves to one question and one follow-up question? The next question comes from the line of Caitlin Burrows of Goldman Sachs. You may proceed.

Hi. Good morning out there. Maybe just on pricing, back in November, you mentioned an estimate of like 10% to 15% mark to markets across the portfolio. So just wondering if you could give your latest view on that and also clarify whether that assumes flat market rents going forward.

Hey, Caitlin, it's Elliot. We're between 5 and 10% today and if you think about the difference between then and now, we've had rent bumps in our leases and we've signed leases that in the large part we're rolling up. So that's where we stand today versus then. We have no future growth assumed in that number. That's a snapshot of where we are right now.

Okay, and then maybe separately on the dividend, I mean, some peers have reduced, suspended, or commented that they could cut if the environment persists or weakens. So, could you just comment on how you feel about the Kilroy current dividend coverage and under what scenario Kilroy could consider modifying the dividend?

So, our payout ratio is quite low. We think our dividend is very well covered. and obviously we have requirements to pay out a certain portion of taxable income. So while ultimately this is a Board decision, we're comfortable with where we are today.

Thank you. The next question comes from Michael Griffin of Citi. You may proceed.

Great, thanks. First, congrats, John, and a great career. Pleasure working with you. Maybe starting on leasing, going to Rob. It looks like leasing is down in the quarter, but second-gen leasing is up. They got last quarter's settlement leasing. Cash rent spreads look down. The retention ratio is a bit low. I think Elliot talked about it last quarter. Maybe give us a sense of what the expectations for this are for the remainder of the year. Rob, I think you talked about a little bit of prepared remarks, but Any additional color around leasing activity would be helpful.

Sure. Let me touch on a few things. You know, what I would say big picture, Michael, is that we're in this great rebalancing right now. We've gone from a very employee sort of dominated market to one where it's now pushed back to the employer, meaning power leverage is back to the employer. And so you see this across the board with companies bringing their employees back to work. That rebalance is underway and it's going to take time to settle out. But in San Francisco, since you were last out there, there's a marked change once again in terms of the numbers of people downtown. And that's just by analogy. And our parking garages are full. So you have that going on. And I'd like to focus a little bit of this on San Francisco because it has been so beat up in the press, and some of it is justified, but San Francisco is still a thriving city, and it has a very strong attraction to young, educated workers in the market. Right now, there's approximately 152 tenants in the market with a total demand of about 3.3 million square feet. Now, that's down, obviously, from the high in 2019, where that might have been 8 million square feet, But I want to point that out just because people have a sense that everyone's sitting on the sidelines, and that's not the case. Of those 152, 120 of them are active, and 32 of those are pending, meaning they're close to getting a lease executed. A lot of the activity in San Francisco is generated by AI. And I think that while AI companies have made headlines I don't think it's appreciated that the majority of AI companies founded since 2020 are located in San Francisco. And this has resulted, as John said, in the Bay Area or San Francisco specifically being home to 40% of the AI companies out there in the U.S. And those companies are producing the most research papers on the topic and variations of AI. So I think AI is just one segment of where innovation and creativity creativity and what we're all known for in the United States in terms of entrepreneurial spirit are going to go. In our other markets like Seattle, I guess I'd say that other markets are going to react in different ways, meaning some will recover quicker than others. San Francisco has a lot of space to clear, subway space, et cetera. Seattle, less so. But Seattle also has a really vibrant scientific technology market. And I'd finish with this point, which For quite a few years, Hollywood had very muted activity in terms of leasing. And right now on space that we have in Hollywood, we've had more activity there, and we have more activity than we have space available. And so it just shows that, you know, in a diversified geographic portfolio like Kilroy has, it's not all down and it's not all up. You have just different dynamics going at any given time.

I just want to pipe in here, Michael, and thanks for the comments. It's really a tale of two cities, so to speak. We've been talking about and others have talked about the differential between premier product and non-premier, the flight to quality and so forth. Last week, a bunch of us met with all our management teams matter of fact, the entire offices at each region over the last six, seven days. And what I was just blown away from in San Francisco is we reported, I think it was probably the fourth quarter call, that the difference between post-Labor Day and pre-Labor Day was just extraordinary. that there were so many people, so many more people back to work, the utilization rates had gone up quite a bit, the traffic had gone up, et cetera, et cetera. Well, there's been another quantum jump, frankly, in San Francisco and Seattle and certain areas of LA since that last call, over the last three months, that is. And it literally, I couldn't get into our parking structure where our offices, we have a big parking structure there in San Francisco the other day, it was totally full. The lobby was totally full, the elevators, were up and down. People were all over the place looking at Salesforce Tower next door in their lobby from where my office is. It was the same thing there, the same thing over at 350. And you just see so many more people. Now, we still have homeless problems. We still have crime problems. We still have a bunch of other problems. Those are being chipped away at. But there's some really positive things going on with people coming back to work. And it's going to be, I think, materially I think there's another quantum jump ready to occur over the next three months or so with the big announcements like Amazon up in Seattle and some of the others in the Bay Area of getting back to work. Now, contrast that with San Diego, which is, you know, in most cases booming. And often when we were there, I mean, it's just on fire with people. So I have a feeling, particularly in the premier properties where people want to be, that we're going to see some material growth. improvements in this whole thing about return to office. But I would also say on the other side, you know, the tale of two cities, there are a lot of buildings that are just going to have problems. When I was in San Francisco, I was walking around in certain areas where we haven't invested, and it was a wholly different world in terms of much fewer people walking around, garages that weren't full, and nobody in the lobbies. And I think that's what you're going to see more and more, and we've been forecasting that for some period of time.

Just quick follow-up on Seattle. John or Rob, any update on West Dates with Amazon there? I think the lease expired this month. I just didn't see any news about it, so anything you can comment would be helpful.

Hey, Michael. I don't want to comment on Amazon specifically, but I think as we pointed out on either at NAREIT or different meetings, literally the week of January 1st, we had a group up in Seattle, John, Justin, Smart and others, and we evaluated the West States project from what do we need to do, if anything, to refresh it. And after that meeting, we've come back with a program that we think is really going to put the project, it's already a great location and great project, great bones, but we're going to modernize a few areas that we think are going to be really attractive to tenants. We've already had, since we've announced the fact that we're going to be doing some renovations We've had several tours and inquiries coming up. So we're very busy right now in terms of generating renderings and imagery to help sell the story of what West 8th will become. And again, I'll remind you, it's situated at the Denny Regrade, which is on the border of South Lake Union, where all the technology companies are, not just Amazon. So we feel good about it.

Great. And then just one follow up. I know I'm breaking the two question rule. So apologies. Um, the Google announcement down the peninsula, San Jose, the pause on the mega campus, is there any benefit maybe in your Menlo or I think the mountain, but any benefit you could maybe have from them pausing that?

Well, I, you know, I don't know if specifically it'll help, uh, Kilroy in any instance I can tell you, but anytime people. don't proceed with new development generally is good for existing product, right? Uh, just because it, it, it, it doesn't rob, uh, others or, or, or whatever. So, um, you know, I, I know more about, um, some of these companies plans and I can share, or we do, uh, I was with, uh, a major tech executive, uh, yesterday and last evening for dinner and, uh, uh, There definitely is a, I think it's a very healthy view coming out, which is we don't need to own everything ourselves. We don't need to develop everything all at once. We really need to demonstrate to the market that we're serious about cost containment and so forth. And if people delay major facilities, then it probably means the people that were going to go in there are going to stay somewhere else. or go somewhere else.

Thank you. The next question comes from the line of Blaine Heck of Wells Fargo. Please proceed.

Great, thanks. Just a couple quick ones for me. We noticed the Wright Games upcoming lease expiration increased in size by about 30,000 square feet. Can you talk about the situation there? What caused that change in any color on the likelihood of renewal or move out at that space?

Yeah, Blaine, this is Elliot. So just on the 30,000 feet, nothing actually changed there. If you look at our lease expiration schedules in 20 and 21, there's no uptick. We clarified the footnote last quarter. We called out the major piece of Riot's lease. They have a few smaller suites that are part of that. So we just wanted to clarify to be a little bit more conclusive with the number.

And Blaine, this is Rob. In terms of Riot, you know, I'm not going to be real specific, but they are in space actively using it, and it's too early. They don't expire until November of this year, so more to come.

Okay, that's helpful. And then, Elliot, I think you talked about parking income being one of the drivers behind the strong same-store results. Can you just talk about that a little bit more? Was the parking income higher than your original expectations this quarter, and how should we think about that income trending for the rest of the year?

Yeah, it was both higher than our expectation and higher than than last year. And I think that that's a testament to what John said in his prepared remarks that we're just seeing better physical occupancy. So it's our, it's our hope that as that continues, we continue to benefit on the parking side as well.

Great. Thanks. Yes.

Thank you. The next question comes from Jay Posket of Evercore ISI. Please proceed.

Great. Thanks for taking my question. I'm just curious if you could provide a little bit of color on the Austin market and just any interest you're seeing at Indeed Tower. I saw a little bit of progress this quarter in terms of leasing, but any color there would be great.

Sure. This is Rob again. As we've said before, the beauty of the Indeed Tower that we have in the CBD is that that part of town attracts not only tech, but finance, insurance, professional services firms, and all of our leasing, other than Indeed, most of our leasing has been in those categories. We're very pleased with the activity we have. Some of it's taking a little longer to get signed off on, but you know, we're going to do well. And there are other tenants in the market. There are, as of yesterday, another big tenant popped up. I'm not sure they're a CBD tenant. But Austin continues to attract companies that are not located there. And the companies that are in Austin are, I would say, being cautious about taking new space. The conversations we've had indicate that they want to bring more people to that market. Um, you know, I would summarize to say we're really happy with where we are, both in terms of rents lease up and what we have in the pipeline.

You know, there's flight to call it this John, that flight to quality thing is alive and well in, uh, Austin as well. Some of the deals we've done are people that had much lower rents in older buildings. And, uh, they just decided it didn't work for their workforce. They needed to step up. We've got a bunch of that in the, in the hopper. But every time there is a bank crisis or whatever, people just say, well, let's go get some more authority. So some of these things have been approved by senior management two or three times, and it just takes a while. That's a little frustrating from our standpoint, but we got a lot of paperwork exchanging, and that building is amazing, and it's drawn a really great crowd. Um, the, the retail or the restaurant situation there, we've come to, we haven't completed the documentation, but we've come to a deal with one of the best restaurant operators. And their thing is like, this is just amazing. It's exactly our clientele. Um, I was, as I said, we were there last week, last Thursday and Friday. And, uh, Austin is, it's, I know some other stuff I can't share with you, but I think it's all, most of it's pretty much, um, I think, understood. The number of companies that are looking to come to Austin right now is breathtaking. I mean, it's breathtaking.

That's helpful. Thank you. And then just one quick follow-up question. I think on the last call, you mentioned that Indeed Tower is going to be placed into the portfolio in the fourth quarter. Do I remember that correctly?

That's right.

Okay. Thanks. That's all for me.

Thank you. The next question comes from Camille Bonnell of Bank of America. Please proceed.

Curious to get your latest thoughts on the transaction market and views on pricing for office. We understand there's a lot going on in the negotiation process, but we're seeing more headlines out there about bids for assets valuing office anywhere from 2050 to 80% down from pre-pandemic levels. particularly in the West Coast markets. Just given that many of these transactions are still pending, I wanted to get your perspective on how much we should really be reading into this.

Well, this is John. I made it pretty clear in my comments at the various conferences and our public things that around 70%, as we calculated, of the office stock in the United States is either obsolete or soon to be obsolete. If something is trading, I haven't heard of anything trading at 80% off. But if you've got a lousy building and nobody wants it and it's vacant, it may not be worth anything. It may be worth what the land value is, less the demo costs. And so I can't really comment without specifics. In terms of the valuations being down, well, that's always going to happen when you have interest rates go up, cap rates go up. go up and so forth. So I would say, yeah, values are down. There's not the degree of a functioning market that we'd like to see, and that won't really be there other than for high quality stuff until the interest rates sort themselves out and availability of debt and so forth sorts itself out. Having said that, I think that if you are on the high quality assets at the great location, Whatever it's off, it's going to be off a lot less than if you are at the other end of the spectrum, which you're not in the right location or you don't have the right quality of building or a combination of both. There's just a whole bunch of stuff that's come on the market that people have tried to put on the market. We wouldn't even look at it. It was a stinker at the best of times, and it's even worse today. There have been some assets that people have wanted to trade. I can't speak too specifically because we signed an NDA when we looked at some of the stuff that are reasonably good assets and good markets and whatnot, but they had specific issues related to them with way too much capex or whatever, and they were big, and they didn't get a bid that was satisfactory, and they pulled them off the market. Well, that's going to happen too. In terms of price discovery, until there's some really you know, some volume of transactions, Camille. I just think it's, you kind of guess. I wouldn't read too much into it. Other than directionally, if it's an older building, old doesn't necessarily mean bad. There's some great buildings. If you look at New York, like the Pornado's post office project, they leased to Meta. I mean, that's a classic case of an older building that fit a company's needs beautifully. It's fabulously improved. It's a great, great asset as an example. But if you happen to have an asset that is like a lot of stuff in some of the cities that was built back in the 60s and 70s with lower ceiling heights and lousy elevators and you really can't improve things, you've got a wasting asset. And so it's a problem. And then we also have the issue of for those that have a lot of project-level debt, and they have short-terms remaining on their debt, they always have a problem. For example, say you have a big building, a tenant, and you're going to put up $50 million in CapEx, and it's a good deal, but you have two years left on your loan, and if your loan was at an interest rate that's significantly lower than today's replacement loan, then do you put up the $50 million? You probably say, we need to renegotiate. So there's a lot of stuff that's going on. Older product that's falling in value, higher interest rates, which confuse the debt market and so forth, and then folks that have too much debt. And we don't have much debt at the property level at all. We have really good assets that are really young. And we think we're pretty well positioned. So a lot of this stuff is going to be noisy.

Appreciate the call there. And on a separate topic, it was touched on a bit earlier around the sublease space you see in the market. But could you talk about what that activity is within the portfolio? And has there been any material pickup in any of your markets over the quarter?

Yeah. Camille, this is Rob. We have about, and this is available sublease space in our entire portfolio. It's just under about a million and a half square feet. And again, what we found is that the best sublease space in any market is going quickly. So, for example, 350 Mission last year, Salesforce is subleasing both to Yelp and to Sephora. That space moved quickly, and that's what you're going to see. Sort of tacking off what John had said earlier, when you look in a market like Seattle, 82% of the leasing that happened in Seattle in the quarter was Class A space, while the Class B space struggles. So you're just going to keep seeing that trend, and that quality sublease space will burn off quickly, and then we'll be going back to more direct space that's Class A in the market over time.

One of the problems with sublease space, and that's not to say that these things are positive. I mean, the reality is sublease space is a bit tricky. Let's say a tenant has a, I don't know, 500,000 feet, or make it 100,000 feet, make it easy, 100,000 square feet of direct obligation, and they have a three years left, five years left on their lease, and they have options to renew. And you have a tenant comes in, you're subleasing it for 20,000 square feet, and they want options to renew. Well, the primary tenant, the sub-lessor, is not going to say, well, I can give you options to renew and obligate themselves to exercise an obligation to create an obligation to exercise their own option. So depending upon a particular building, not just the quality of it, but the structure of the lease that the primary tenant has with the landlord, it can trip people up. If it's ready to go space and you're looking for something for fairly short term and you can get it cheap, that's a great deal for somebody. But it's generally more complicated than that.

Thank you for the explanation and taking my question.

You're welcome. Have a good day.

Thank you. The next question comes from Teo Okusanya of Credit Suisse. Please proceed.

Yes, good morning out there. Let me add my congratulations about your retirement, John, and I can bet we'll still be hearing much more from you going forward. My question has to do more with the occupancy guidance for the year. I'm just trying to understand what's going into that number, whether it's just the noon move outs and whether there's some type of buffer in that number for kind of anything else that may be coming. And I ask that in the context of trying to understand what your watch list looks like today, just kind of giving some of the incremental challenges in the tech and biotech industries right now.

Yeah. Hey, Teo. It's Elliot. So similar to what we talked about last quarter, The occupancy guidance factors in the move outs and the move in that we've projected and the big ones are the ones that we've talked about earlier, but Amazon, Pac 12, et cetera. We do have some move in those are weighted towards the later part of the year. So, as we think about the average occupancy, you know, So we dropped a little bit in the first quarter. We expect to drop more in the second quarter because that's when Amazon will happen. It gets a little bit steadier in the back half of the year. But as we think about the average, that's really what's driving it. And then in terms of your second question on the watch list, the majority of our watch list is still concentrated around retail tenants, although we have seen a modest uptick in kind of our office and life science tenants. It still makes up a pretty small part of the overall portfolio, though.

But is there any factoring of some of those things at terminating? This year, like, you know, like the Sorento example, like, the stuff like that that may be on the watch list and ultimately become a move-out? Is that some provisions of stuff like that?

No, I mean, obviously, there's a range of outcomes. But we don't project watch list tenants leaving the portfolio.

Gotcha. All right. Thank you.

Thank you. The next question comes from Dylan Verbinski of Green Street. Please proceed.

Hi, guys. Thanks for taking the question. Just curious because I know face rents have been able to hold face rents over the last several years, but just given that availability rates across most of your markets are rising and leasing backdrop is likely weakening. Do you see a scenario playing out where we actually start to see pressure on face rents in 2023?

Yeah, this is John speaking. I think that's a good question. Reminds to be played out for sure. You know, The concessions can change, the amount of TI you put up, things like that. So net effective rents, will they deteriorate? That's probably likely if we continue to see this thing persist. But against that backdrop, it's also a question of how much availability is there. And so having gone through this for a long time in my life, I'd always say that more availability is not generally a good thing unless you're a tenant. On the other hand, we have this other factor that has become so important, which is it's all about the people and being able to attract and retain the right people, and it's becoming more binary. This building fits and I'll pay up for it, and this building, even though it's cheap, I don't want it. And that's always been a factor amongst different qualities or locations. But now it's become a much bigger factor with regard to just what people want for their student body. I mentioned in my prepared remarks that we want to be one of the three or four different buildings that are shown. If you've got 20 vacancies or 20 possibilities or 50 possibilities or 100 possibilities or whatever it is in a market, As Rob has mentioned in prior calls, you're not going to go tour all those buildings. You're going to tour one, two, or three. And you want to make sure that you've got the presence, whether it's your outside areas, your lobby areas, your common areas. If you have conference centers or gyms or things like that, you really want to present yourself well so people can see that it's a plug and play. And that's what we do really well. So we feel that we're going to continue to do well. how it plays out on rates i don't know i i i've seen less resistance to paying higher rates uh in this last year or two than i had anticipated i can't tell you if that holds that's helpful thanks and then just maybe one bigger picture one because i think in the last several comments called you guys have mentioned ai the potential positive for san francisco leasing activity but

I guess just from looking at what the technology will be used for, right, the displacement of white-collar jobs could also be viewed as a potential risk to future office demand?

Yeah, I think you're right. I think that takes a long time. And I can't, I'm not an expert in this area. I have a lot of friends that are. And some of them are, you know, extremely well-known in this space. And it seems to me that, and again, I'm not an expert, I think what's going to happen is back office kind of things are going to be decimated. Anything that's mostly processed and not brain is going to be materially impacted. That's what's going to happen first. And you can get into all kinds of questions about AI, about its potential for reducing the workforce. and creating a new level, a higher level of what's considered full employment, meaning higher level of unemployed. You can get into all kinds of moral discussions about it as well, which I don't want to do. But the nature of technology is it's disruptive. If you want to make money from it, you figure out how to utilize it. And if you're in the real estate business, you figure out how you present yourself as a property of choice. How big it's going to be, I don't know, but everything I hear is it's going to be huge. It's so early, how do you know?

Dylan, this is Elliot. One thing that I'd add to that is when you look at a lot of the innovation that has come from places like the Bay Area, you could argue that some of that should have displaced jobs, white collar jobs as well. And what in turn, what often winds up happening is it just makes it more efficient for people and allows them to innovate in different ways, right? And so if you think about AI helping somebody code or an engineer, that engineer can be a lot more productive and now the realm of options or possibilities that they can innovate has grown exponentially. That allows for a greater multiplier effect. So it could actually really go the other way where it helps more innovation, more company growth, et cetera.

Well, that's exactly what's happened over the last 20 years. All these technologies that came along that were going to put everybody out of work and so forth actually went the other way and they've become the getting the biggest consumers of space, right, and the biggest hires. If I knew the answer to that question, I'd be investing in a different area.

No, I appreciate the call. That was very helpful. Thanks, guys.

Thank you. There are currently no additional questions registered at this time, so I will pass the conference back over to Mr. Hutchison. for any closing remarks.

Daniel, thank you for your assistance today and thank you everyone for joining us. We appreciate your continued interest in Kilroy.

And with that, we will conclude today's conference call. Thank you for participating. You may now disconnect your