Kilroy Realty Corporation

Hello, everyone, and thank you for joining the KRC 3Q24 earnings conference call. My name is Harry, and I'll be coordinating your call today. All lines are currently in listen-only mode, and there'll be an opportunity for Q&A after management's prepared remarks. If you would like to enter the queue for questions, please dial star followed by one on your telephone keypad. If you change your mind, please dial star followed by two to exit the queue. It is now my pleasure to hand you over to your host, Taylor Friend, Senior Vice President, Capital Markets, and Treasurer to begin. Please go ahead.

Good morning, everyone. Thank you for joining us. On the call with me today are Angela Ahman, CEO, Jeffrey Keeling, EVP, CFO, and Elliot Trencher, EVP, CIO. In addition, Justin Smart, President, and Rob Peratt, EVP, Chief Leasing Officer, will be available for Q&A. 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 webcast live on our website and will be available for replay for the next eight days. Our earnings release and supplemental package have been filed on a Form 8K with the SEC, and both are also available on our website. Angela will start the call with a strategic overview and quarterly highlights. Elliot will discuss our recent capital allocation activities with the Transaction Market Outlook, and Jeffrey will discuss our financial results and provide you with updated 2024 guidance. Then we will be happy to take your questions. Angela?

Thanks, Taylor. I'm pleased to report on a strong quarter of execution as we continue to navigate a challenging but steadily recovering operational environment. Kilroy's high-quality, well-amenitized portfolio differentiated tenant relationships, experienced and talented team, strong balance sheet, and robust liquidity profile uniquely position this platform to capitalize on the recovery that continues to take hold across our markets. Our third quarter financial and operational results speak to this dynamic. FFO for the third quarter was $1.17 per share, a sequential increase of 7 cents due to a combination of recurring and non-recurring items, which Jeffrey will cover in a few minutes. Based on our strong third quarter performance and outlook, for the balance of the year, we increased our full year FFO guidance by 15 cents per share at the midpoint of the range. During the period, we signed approximately 436,000 square feet of leases, including 209,000 square feet of short-term leases. In addition, we also signed 110,000 square foot short-term lease related to the DermTech bankruptcy. The short-term leasing activity this quarter was predominantly comprised of renewal for tenants that will be vacating or significantly downsizing in the portfolio in the near term. Excluding short-term transactions, the weighted average lease term on executed deals was approximately five and a half years, with cash leasing spreads of approximately 7%. Notable transactions this quarter included the previously announced 118,000 square foot SAP renewal in Bellevue, Washington, and a new 28,000 square foot lease with NVIDIA and Southlake Union. Recent leasing activity, in conjunction with an early rent commencement on a previously executed new lease, drove a 75 basis point increase in the midpoint of our average occupancy guidance to 84%. As SAP, NVIDIA, and late stage deals in our future pipeline highlight, we continue to see robust demand in Bellevue and are beginning to see signs of a pickup in demand in South Lake Union and Seattle. Amazon's recent five-day return to office announcement is further accelerating the dynamics that we have seen in the Pacific Northwest over the course of 2024 and is the latest in a series of announcements from major West Coast employers that had worked hard to embrace remote work, only to arrive at the conclusion that in-person collaboration is the most effective way to enhance innovation and productivity and build a differentiated culture that drives long-term sustainable performance. In San Diego, where physical occupancy has been at pre-pandemic levels for some time, we continue to experience strong demand, and recently we have seen a notable uptick in interest from existing tenants looking to expand within our portfolio. In several instances, this demand is coming from tenants that previously downsized but are now realizing that they underestimated their utilization and optimal real estate requirements and are looking for opportunities to course correct. In Los Angeles, while aggregate demand remains soft, We continue to execute well, driving improvements in sequential occupancy in each of our submarkets. Of note, we continue to see solid activity in Long Beach and have recently seen a nice uptick in interest in Culver City, driven by professional service and technology tenants. And in San Francisco, we remain encouraged by ongoing improvements in physical occupancy, foot traffic, and the overall vibrancy of the city. The momentum being created by the continued growth and evolution of the AI industry has been and will continue to be a significant catalyst for this market. The Bay Area commands by far the highest proportion of AI-related VC investment in the country, which is actively driving significant levels of new business formation, a very positive longer-term trend for this market. While to date many early-stage AI tenants have focused their real estate searches on sublease space that is immediately available for occupancy, It's worth noting that approximately half of the remaining available sublease space in the market has a lease expiration prior to the end of 2026, limiting the attractiveness of the space to many users. As a result, prospective tenants are shifting their focus to direct deals, and we're working hard to capitalize on this dynamic by leveraging our well-developed and thoughtfully executed SpecSuite's program. As it relates to Kilroy Oyster Point in South San Francisco, we are excited to begin delivery of the second phase of this extraordinary campus next month. In early 2024, we described a meaningful acceleration in tour activity off of a very low 2023 base. That higher level of interest in tour activity has remained relatively consistent throughout 2024. But over the last two to three months, we've seen a crystallization of this demand as tour activity has expanded to include a much wider range of potential tenants, and these tenants appear more prepared to execute. Recently, we have spent time onsite with early and late stage life science companies research institutions, technology companies, and other more traditional office users. While there's no question that the deal process has become significantly elongated, we remain highly convicted in the quality of what we are delivering and its unique ability to cater to a wide range of highly discerning tenants. While Elliot will discuss the transaction market in more detail in a moment, I will note that the environment is clearly evolving. Financing markets, while still challenging, are improving. leading more sellers to test the market. As a result, Elliott and team are spending more time evaluating actionable deals through a disciplined, risk-adjusted return framework, while also making good progress on the land sales discussed last quarter. In addition, I'm delighted to announce our recent acquisition of Junction at Del Mar, 104,000 square foot, two-building campus, located strategically adjacent to Kilroy's One Paseo mixed-use project in the Del Mar Heights Submarket of San Diego. While a small transaction, this deal represents an excellent value proposition for the company, increasing our presence in one of our strongest existing submarkets and achieving a very compelling risk-adjusted return on an as-is basis, with additional potential upside from longer-term redevelopment and integration with OnePaseo. Before turning the call over to Elliot, I want to take a moment to thank the entire Kilroy team for the hard work, dedication, and flexibility I've seen every day since joining this platform. It has been gratifying to see the way this organization confronts challenges, leans into opportunities, and embraces change. And I'm excited to see what we can deliver together in 2025. Elliot?

Thanks, Angela. As Angela mentioned, at the end of the quarter, we acquired Junction at Del Mar in San Diego, our first acquisition since 2021. This opportunity was attractive because of the premier location, additional scale and a strong sub-market, ability for Kilroy to uniquely add value, in-place income, and lease term. The buildings are adjacent to our Juan Paseo campus, and by consolidating ownership, we can drive value creation through better integration to the nearly 700,000 square feet of office and retail we have next door. The purchase price was $35 million, which equates to approximately $335 per square foot, or a low double-digit stabilized yield. The project is 96% leased to a variety of tenants with a weighted average term of over four and a half years. In the few weeks since we have closed on the deal, we have seen good interest in the remaining vacancy at terms consistent with our underwriting. Longer term, and depending on market conditions, we may consider additional redevelopment opportunities on site. Turning to land sales, we are working on monetizing several parcels in our future development pipeline. Strategically, the rationale is threefold. First, after thorough evaluation, we believe that the highest and best use of these particular sites is something other than office and life science, and as a result, our resources are better focused elsewhere. Second, these sales help right-size our land bank for the current environment, and finally, it allows us to raise attractively priced capital to be acquisitive when appropriate. We have advanced negotiations with multiple sophisticated groups that support our thesis behind a re-entitlement, but as previously discussed, it will take longer to realize proceeds. To put some numbers around this, the two deals furthest along are projected to generate in excess of $150 million, and we hope to have more to discuss in future quarters as these transactions advance. Bigger picture, the capital markets continue to strengthen as lending is up year over year, driven by a strong recovery in the CMBS market and an improving leasing market that allows buyers and sellers to underwrite more thoughtfully. As a result, transaction volume has increased compared to last year, and high-quality office and life science opportunities are starting to surface. To this end, there have been a few core office deals trade in our markets at cap rates ranging from the mid-6 to low-7% range. In summary, as we demonstrated this quarter, we are prepared to transact when the right deal comes along, and we are hopeful that we can find additional opportunities as both a buyer and a seller in the coming quarters. With that, I will turn the call over to Jeffrey.

Thanks, Elliot. Since joining Kilroy in late August, I've spent my time getting to know our team and portfolio, and I'm excited to work closely with Angela and the rest of the executive team to deliver value and drive outperformance going forward. FFO was $1.17 per diluted share in the third quarter and was impacted by several one-time items totaling approximately $0.05 per share, including $2.6 million of bankruptcy settlement income, $2.2 million of restoration fee income, and $1.4 million related to real estate tax appeals. Cash same property NOI growth was 2.7% in the third quarter, including a 230 basis point impact related to the aforementioned one-time items. In terms of our forward outlook, we've increased 2024 guidance for same property NOI growth to a range of minus 2 to minus 1.5%, a 175 basis point increase at the midpoint of the range. Our improved outlook is driven by the increase in our full-year average occupancy projection, which Angela discussed earlier, the cash impact of our non-recurring items in the third quarter, and cash restoration fee income expected in the fourth quarter. In addition, we have updated our 2024 FFO guidance range to 438 to 444 per share, representing an increase of 15 cents at the midpoint. The revised guidance reflects our updated same property NOI growth and G&A guidance, as well as the expected contribution of our Junction at Del Mar acquisition in the fourth quarter. Our G&A guidance range was narrowed and lowered by one million at the midpoint, reflecting a variety of ongoing G&A initiatives that have refocused resources across the platform with the goal of improving the efficiency and effectiveness of our G&A spend. The midpoint of our updated full-year FFO guidance implies fourth quarter FFO of $1.03 per share, a 14-cent decrease from the third quarter. To bridge there, subtract $0.05 related to the previously discussed one-time items in the third quarter, $0.04 related to lower sequential gap net operating income due primarily to fourth quarter anticipated moveouts, $0.03 related to lower interest income net of lower interest expense, and $0.02 related to the timing of G&A spend. Turning to development activity, as Angela highlighted, we're excited to be approaching the delivery of Kilroy Oyster Point in the fourth quarter of this year. As the project was the primary driver of our development spending during 2024, we expect development spending to moderate in 2025 pending future TI capital outlays. As a reminder, for KOP Phase 2, interest capitalization will cease at the earlier of tenant occupancy or one year from base building completion, which is expected to predominantly occur in the fourth quarter of 2025. With respect to the future development pipeline, as Elliot highlighted, we continue to work towards the monetization of several parcels that we now believe are the highest and best use outside of the company's core competencies. As we continue to evaluate and begin executing on a disposition program to maximize shareholder value, the continued capitalization of interest may not be appropriate in all cases. As our disposition plans gain traction, we will be able to provide more detail on what this will mean for 2025, but we do currently expect that capitalized interest will be lower next year. Finally, from a balance sheet perspective, we're exceptionally well positioned with $1.7 billion of available liquidity. While we'll use cash on hand in the fourth quarter to repay our scheduled bond maturity, we still expect to end the year with significant cash on hand and a fully undrawn credit facility, providing us with ample flexibility and capacity to navigate a dynamic operational, transactional, and capital markets environment for 2025. With that, we're happy to take your questions. Operator?

Thank you. If you would like to ask a question, please dial star followed by one on your telephone keypad now. If you change your mind, please dial star followed by two to exit the queue. And when preparing to ask your question, please ensure that your phone is unmuted locally. Finally, we respectfully ask that you limit yourselves to just one question and one follow up per person. Our first question today will be from the line of Nick Ulico with Scotiabank. Please go ahead. Your line is now open.

Uh, thanks. Uh, I guess first question, if you could just talk a little bit more about, uh, oyster point phase two, and, you know, you, you mentioned, uh, some traditional office users potentially being candidates. If you could just talk about, you know, what, what dynamic is making that, uh, potential for the project. And then also, uh, in terms of the, um, the tenants in the first phase, uh, whether any of them might be expansion candidates for phase two.

Yeah, thanks, Nick. I'll start, and then I'll turn it over to Rob to provide a few more specifics. I would just say, you know, as I mentioned in my prepared remarks, we're really convicted about the quality of what we're delivering in Oyster Point, and the closer we get to delivery of that project, the more you can see sort of the unique attributes of the campus, the amenities that we're putting in there, and that's certainly improving sort of the relevancy on the tours, you know, just what this project is and what it will be to the tenants that end up locating here. In terms of the demand I mentioned or tour and interest activity we've seen from traditional office users, I think it's really just a reflection of the quality of the project that's being delivered and the fact that we have, as you know, in phase one, an office tenant already that's very successful and very happy at the project as well. So I don't think there's anything more to it than that. It's really just a very high-quality project delivering with a really fantastic amenity package. Rob?

Hi, Nick. You know, I guess I'd say also kind of going off Angela's comments, the landscaping is now, I'd say, about two-thirds of the way installed, and that makes a huge difference in the project. And we're now, for the first time, presenting inside our fully fitted out conference center. So our prospects really get a sense of what it's going to be like at Oyster Point. And I think kind of going further on the demand and what we're seeing, as I've said before, we're delivering into a really positive environment. VC funding for the quarter is at 2.6 billion. In the year to date number is about 9.9 billion, which is about a billion more than the quarter before. So we're seeing an improved funding environment, which is leading to more demand. Demand has remained steady at about 2.8 million square feet. And I think for us, particularly at Oyster Point, one of the things we're seeing is larger format tenants coming into the market. And a good proportion of them are larger than 44,000 feet, which is a single floor for us. So all things are coming together. It's a really busy place right now and are sort of going off what Angela said also, our tour activity and presentations have accelerated in the last month to six weeks.

Yeah, and just on the second part of your question in terms of the two tenants we have in phase one you know, the likelihood that either of them expands into Phase 2. I would just say we've got two very successful tenants in Phase 1 of the project, both of whom, you know, I believe are extraordinarily happy at Oyster Point. And I would say I do think there is long-term, you know, expansion potential for one or both of those tenants. At this point, my expectations would be that that's most likely for phases beyond Phase 2.

Okay, thanks. That's helpful. Second question is just on the short-term leases. So, now you talked about that, you know, saying in many cases it could be tenants leaving in the future or downsizing in the future. So, is there a way to just put some numbers around this? When we look at, you know, the short-term leases that were announced year-to-date, it looks like it's about 340,000 square feet, 2% of the portfolio, I imagine. I think there was also some short-term leases last year so we're just trying to understand like how much that occupancy benefit I guess is is in this year or maybe even helped with some of the the occupancy guidance revision higher but we should think about as you know at some point next year it's occupancy that that could go away thanks yeah thanks Nick I appreciate it I'll say a couple of things number one

Anything that we've disclosed as a short-term renewal is already reflected in the lease expiration schedule you see in the supplemental, so you have full visibility to all of those short-term renewal activities. So during the quarter, you know, the short-term activity we announced was primarily related to one large renewal for Capital One on a short-term basis in San Francisco. That's going to extend that maturity just a couple months, so it's still a 2024 expiration, but again, reflected in the lease expiration schedule you see. The only thing that was significantly different than that kind of activity are really two things that varied from that. First, the larger format short-term lease we announced, I believe, in the first quarter of this year, which is 75,000 to 100,000 square feet. That took occupancy this quarter. We'll be exiting the portfolio in the fourth quarter of this year. And then the second more unusual transaction was the new lease we signed with the successor entity to DermTech this quarter. that's going to keep them in occupancy through this year and to mid-first quarter next year. And that's one where we do expect a vacate or a significant downsize, but are in discussions with them now.

Our next question today is from the line of Upal Rana with Key Corp. Please go ahead. Your line is now open.

Great. Thanks for taking my question. Good morning. Could you provide some color on your decision to acquire It seems like the market's pretty tight. Is there any kind of long-term plans to maybe integrate with One Paseo there? That'd be great.

Yeah, I'll make a few comments and then turn it over to Elliot for additional commentary. But, you know, this is located really adjacent to our One Paseo project, which is an incredibly successful mixed-use project that the company has developed. And I would say there are strategic benefits longer term as we think about how this site could potentially be redeveloped and further integrated with OnePaseo. But as I think you also heard Elliot really highlight in his prepared remarks, this was also a very attractive deal on an as-is basis if there's no redevelopment play given the cap rate that it was acquired at and the lease term we have with existing tenants and just really how tight that sub-market is. As we mentioned, it's one of our most successful sub-markets in the portfolio. We ourselves are you know, 97, 97 and a half percent leased in Del Mar. And as Elliot highlighted, this acquisition was 96% leased as well. So it's both good income on an as-is basis with, yes, sort of a strategic potential longer-term benefit through redevelopment and further integration with OnePaseo.

Yeah. And, Paul, as we sort of touched on, I mean, this really hits, checks so many boxes for us as an acquisition. We know the market incredibly well. We know the micro location very well. Having so much scale next door allows us to take advantage of that and whether that's as we think about how tenants grow in our portfolio or if there are expenses that we can manage. And then there's also something to say for the brand that we as a company have created at One Paseo and the more we can do to extend that brand and integrate adjacent properties we think is very additive.

TAB, Great that was helpful and then you know, on the development pipeline, could you elaborate on the 4400 Bohannon and 4690 executive drive. TAB, Being moving to the 10 improvement grouping and maybe what it will take for the assets to be placed in service and then building off that in any color on the decision to push the stabilization out of quarter.

Yeah, so this is Elliot, I'll take that. The reason they went into the TI ready phase is because the cold shell is essentially complete and it is more of a technical timeline that we've hit. And so now that we've hit that point in time, our 12 month clock begins for lease up and then at that point the properties will go into the operating portfolio, capitalization will cease, and they will be integrated into our occupancy statistics, et cetera. As far as the leasing market around that, Rob, if you want to touch on that.

Yeah, as kind of going off what Elliot said, as the building has delivered or starting to deliver and the tenant improvements are starting for the spec labs, it's increased our activity there. And as you recall, we did this, we made this decision to move to life science because it gives us a wider net to cast, although there are a lot of, you know, tech companies in the neighborhood. There's also a lot of life science in the area, so we're seeing a good amount of interest on the project. We just had a relatively large broker event last week that was very well attended.

And then just the last piece of your question on the timing on 4690. As you may recall, last year we had a tenant, Sorrento Therapeutics, that was supposed to take that space and declare bankruptcy. We then pivoted and readjusted our design to go from a single tenant use to a multi-tenant use. As we sort of worked through that, it just took a little bit longer in developing those plans, and that was the one-quarter delay.

Our next question today is from the line of Blaine M. Heck with Wells Fargo. Please go ahead. Your line is open.

Okay, great. Good morning out there. So you talked a lot about the land parcel. So related to that, I wanted to ask about Flower Mart. Clearly the pandemic interrupted the plans you had to develop, you know, mixed use space with a lot of office there. But in the past, I think you guys have excluded it from any land parcels you're evaluating for disposition. So can you talk about what the plan is there? Can you adjust the property mix to lean more towards residential or retail? And then, you know, lastly, I believe you're capitalizing interest there. Is there any clear answer to when that could cease?

Yeah, thanks, Blaine. You know, I'll say a few things about Flower Mart. This is a really exceptional assemblage of property in the city of San Francisco. Very well located, accessible, and zoned for pretty high density. And so at the right time, I think there's a lot of reason to be enthusiastic about how Flower Mart ultimately gets developed. Given where the market is right now, that's unlikely to be in the near term. And certainly we're going through an extended process of really understanding what all of our options there and making sure that we're on a path that will ultimately maximize value through whatever eventual outcome that is. I note that right now, you know, we're still working on completing our work at the wholesale flower mart and moving the flower vendors over, so we're still at that stage of the project. But actively working on longer term design and, you know, density considerations at flower mart. The things that make this site, you know, challenging I think in the near term are just making sure while it sounds like a good idea to pivot to alternative uses, I think we have to be really mindful of the fact that we do have such significant density approved at the site. And there are a number of other plans that might be more actionable in the short term that would really impair the eventual ultimate value and realization at Flower Mart. And so those are things that we have to be mindful of. As we continue to work through our plans for that site, you know, we'll have better clarity on sort of what timelines look like for those different plans and what that means for interest capitalization.

Okay, great. That's great, Keller. Just for my second question, another kind of high-level one, over the years, Kilroy, and in particular John, has been very vocal about the need for political reform on the West Coast, and now we're also facing a presidential election that's highly controversial. So I guess from both angles here, Angela, how are you feeling about the political and business environment on the West Coast? I guess, have you seen any improvements in the short time that you've been there? And I'd also be interested in any potential implications you think there could be from the San Francisco election and maybe even federal election, if you have any view there?

Yeah, you know, I'll make a few comments. Obviously, as you point out, the company has been, you know, very politically aware over time and politically active in the markets we operate in, really championing great policy, both from a business perspective, but also just from a quality of life and safety perspective as well. And that's been a huge focus of the company's efforts over the last few years. I would say we have seen, not just during my time, but over the last probably 18 to 24 months, a real improvement in many of the markets we operate in. That's absolutely true in San Francisco, but it's true in our other markets as well, like Seattle and Los Angeles, to varying degrees. We are continuing to monitor all of the election activity really closely. We do feel like what's happening in San Francisco will continue given the way that the mayoral race and the board of supervisor races are shaping up and do feel like we'll continue on the path we've been on, which is, you know, to some degree, more moderate policies that, again, continue to focus on quality of life and safety issues in the cities and really bringing back, you know, employees and residents and really just continuing to improve the overall vibrancy of those markets.

Our next question today will be from the line of Jeffrey Spector with Bank of America, Merrill Lynch. Please go ahead, your line is open.

Great, thank you. Angela, you mentioned in your opening remarks, you know, recovery, but you also said subtle recovery. You know, in New York City, I'm sure you're aware, I mean, I think, you know, one of the key catalysts was companies finally deciding, you know, to stop reducing space. How would, you know, like, I guess, by market, where does that stand? Where do you think that stands in San Francisco or LA or Seattle versus New York City, given everyone's trying to compare? Thank you.

Yeah. Thanks, Jeff. I mean, I'll say a few things. Number one, I think, you know, important commentary made in the prepared remarks was just around some of the recent return to office announcements we've seen. And what I really tried to highlight there is, you know, what we're seeing in this phase of the return to office dynamic is companies that had worked really hard to embrace remote work as a consistent and significant part of their workplace environment that are moving back to environments in particular in Amazon's five-day announcement that represents sort of pre-pandemic norms. And so I think that's certainly a very helpful dynamic overall. I also pointed out, particularly in the San Diego market, but I'll turn it over to Rob to talk more broadly about what we're seeing in other markets, that we have recently seen a pretty significant uptick in terms of tenants looking to expand within the portfolio And then in several instances, and I do think this is a sign of things to come, we're seeing tenants who had reduced space or were actively planning on reducing space in 2025 come back and sort of begin conversations with us because they believe they've overshot those reductions. And now that they're getting people back into the office more consistently, they have a better sense of what their ultimate utilization of real estate requirements are. and are realizing that they're a little bit different. And that is, I'll turn it over to Rob, but we've certainly seen that dynamic, not necessarily within our portfolio, but within the broader markets we operate in, as people who would put sublease space on the market have pulled some back as their plans kind of shift and change.

Yeah, Jeff, just adding on to that, there's a palpable change and difference in the streetscape in all the markets we're operating in for the better. And I'll just tick through a couple. Bellevue, for example, with Amazon being a major employer there, is on track to have about 25,000 employees, Amazon employees, in the office phased in over the next 24 months. So that's a very positive thing for, you know, it's just a virtuous cycle when you get companies bringing people back to work. That helps retail. Retail helps the companies have their employees at work. And we're seeing that happen in Seattle. In addition to Amazon's return to work policy, the city of Seattle and Kings County are mandating a three-day-a-week return to office starting in November for those employees. So in the core, that means about 13,000 more people working in downtown Seattle, which will be nothing but helpful. San Francisco, Salesforce is the most recent and largest to announce a return to office policy that'll take effect, you know, has taken effect, but will really be phased in over the next couple of months. And that's in particular because our San Francisco headquarters office is directly in the middle of the Salesforce campus. There's new restaurants opening. There's a lot going on in San Francisco where even a year ago there wasn't much retail at all. Now we're seeing new openings. Los Angeles, in our markets where we operate, Culver, Hollywood and the west side of LA. People have been back to work and it's continuing to improve. We're starting, if this says anything about it, we're starting to see larger transactions starting to tour the market in places like Playa Vista that had been very slow over the last year. San Diego, Angela hit on and Austin was probably one of the biggest leaders of return to office over time.

Thank you, very helpful. My second question is on external growth, I guess, acquisitions versus development. Junction at Del Mar, I mean, is this, I guess, can you talk a little bit more, Angela, about your strategy over the next few years? Have you changed that external growth strategy from the past a little bit? And is Junction at Del Mar a good example of what we should expect more out of Kilroy? and including, of course, you discussed the land sales.

Yeah, I don't know that there have been huge changes in how we'll approach capital allocation going forward. I mean, I think this is, as we pointed out in the prepared remarks, a real focus on risk-adjusted returns and just making sure we're continuing to deploy capital at levels that represent returns to the company and to our shareholders that are above our cost of capital. It's really no more complicated than that. Junction at Del Mar, I think, was a really fantastic transaction where we're underwriting, as Elliot mentioned in his remarks, a low double-digit stabilized yield, translating into kind of a mid-teens IRR. And even at discounting cost of capital today, I think that transaction makes sense all day long, and then you layer on top of that potential future redevelopment down the road. I think it's a very compelling deal. Now, albeit a very small size at $35 million, but I think it made both financial and strategic sense for the company. I don't think that's necessarily anything dramatically different from what the company would have done historically. We're going to evaluate a wide range of transactions in our markets and I think be very focused on risk-adjusted returns, how we're underwriting cashless streams going forward, how we're thinking about the conviction we have in different sub-markets that we operate in today regarding lease-up and the timing of that lease-up and things like that, and just trying to make sure that we're continuing to put capital to work in ways that will benefit the shareholders.

Our next question today is from the line of Anthony Paolone with JP Morgan. Please go ahead. Your line is open.

Great. Thank you. You talked about the short-term leases, and I know there's some sublease space in the portfolio. And as we look out the next couple of years, the lease expiration schedule spikes. And so maybe, Angela, as we step back and look at this, what's your comfort level for

that we don't see another step down in occupancy the next couple years or you know how do we think about just the path of of just you know absorbing what's coming down the pike yeah i mean i'll talk about it a few ways and we can talk longer term about 2026 and sort of how we're positioning uh for the least expirations that are coming in that year but you know look we were pleased to report an increase in sequential occupancy in the third quarter the team's working really hard across the entirety of the portfolio to prioritize occupancy and getting tenants in and rent paying as quickly as we can. And that came through in some of the deals announced this quarter and also some of the early revenue recognition or early occupancy that we reported that helped drive the occupancy number as well. So I'm pleased to see that sequential increase in occupancy. Obviously, the full-year occupancy guidance does point to deceleration of that occupancy level in the fourth quarter, and that will have something to do with both the short-term Capital One extension we talked about earlier. They will vacate in the fourth quarter, as I previously mentioned, and that shorter-term new lease deal that we had announced in the first quarter took occupancy this quarter and will vacate the portfolio next quarter. in addition to a move out from Microsoft or LinkedIn in the Bay Area. So some pressure in fourth quarter. What we had pointed to in 2025 in particular and have continued to point people to is that that is overall a later expiration year for the company, and it is a more granular pool. So until this quarter, and I'll put one caveat on that, we have had no lease expiration in 2025 greater than 100,000 feet. With the shorter-term Durham Tech deal that was signed this quarter, they will vacate the portfolio in the first quarter, significantly downsize. And as I mentioned, we're in conversations with them now to understand what that looks like. But there will be some space from that 110,000 square foot short-term renewal coming back to us in the middle of the first quarter. So that's the only real update there. So 2025, you know, again, on the move outside feels certainly an easier hill to climb than 2024 was. But you're appropriately, you know, sort of keying in on 2026 being a larger expiration year. And I will just say Rob and team have been very focused on the 2026 expirations really since I joined the company back at the beginning of 2024 and are making good progress, you know, in conversations with many of those tenants already. Rob?

Yeah, I would just add a little more color to that. On the last earnings call, we discussed that tenants now sort of in general are looking, starting to look out further than just their upcoming earnings. expiration and that's being borne out in what we're doing in 2026 and I would say right now you know we have good confidence in the discussions we're having and we're having discussions on over half the space that is expiring in 2026 and these are relatively longer term transactions as well so not the short term that you've seen in the past okay thanks for all that color

My second one is on KOP2. You just talked about the elongated process to try to get things done there. I'm just wondering, is this mainly like competition from other sites that tenants might be looking for and also thinking about what the risk is that you have to offer more in either concessions or up the development budget or whether you have enough room in what's been planned to kind of get it all done?

Yeah, I mean, just from a tone perspective, as I kind of think through all the things in the pipeline we're referring to when we talk about that elongated process, certainly there's plenty of supply in the market, which has been highlighted. And so there is competition for space, but I don't think that's what's been elongating the process as much as it is tenants really just understanding what their requirements are and ultimately being prepared to commit to longer-term deals and move forward. And we do think that that's changing. I mentioned that in my prepared remarks. We feel like we really have seen kind of a continued level throughout 2024 of higher tour activity and interest in the space. We're nearing the delivery of the spec suites in the fourth quarter, so that certainly is creating a little bit more momentum. And it does just feel like what we're seeing is a combination of tenants who are ready to move forward as well as tenants who might have toured the project earlier in the year and, you know, as it turns out, weren't ready to commit at that time, coming back and seeming much more prepared to execute as well. So it feels to me like it's been, and this is not true, obviously, in all circumstances, but it feels like it's been more driven by, you know, tenants really understanding their own needs and their business plan and being ready to commit versus you know, spending a lot of time in the process really evaluating, you know, different options in the market.

Yeah, just to add two things to that. One, you know, as we've talked about before, timing has been an issue with KOP in terms of our delivery, and we're now getting past that. I mean, our spec suites or spec labs are delivering in November, and as I said earlier, the project just shows amazingly right now. The other thing I'd remind you is that life science companies in general are not apt to pre lease, which has also been an issue for us. And now we're in that mode where we're, you know, we're beyond the point of pre leasing and we have shell and core up and amenities in and that's making a big difference in terms of the conversation. So overall, You know, this business is sort of a protracted negotiation business anyway, but we're confident in what we're seeing and the activity that we're working on.

Our next question today is from the line of Michael Griffin with Citigroup. Please go ahead. Your line is open.

Great, thanks. Just wanted to get some more color on the leasing numbers this quarter. Obviously, rent spreads and retention rates were higher relative to 2Q, but you saw a noted jump in tis as well can can you give us any sense on maybe how this has impacted net effective rents are you seeing a greater ability to maybe push face rents but you have to sacrifice more in tis to get deals done just just curious on any color there that would be helpful yeah i mean i'll i'll let rob come in in a minute but i guess what i would say is um you know one one quarter data point doesn't lead to a trend line necessarily i would say

There were a couple of deals in the pipeline or in the deals reported this quarter that just based more on condition of the space than on market dynamics, drove that number to be a little bit higher. And so I, you know, certainly we're in a competitive market environment, but I don't really think that's what drove the number this quarter as opposed to just the condition of the space and more of a mixed issue than a market or trend issue.

Yeah. And Angela hit the nail on the head, Michael. It's the condition of the space in two cases, which were relatively large, the space hadn't been redone for over 10 years by two different tenants. And so to put that in perspective, post-pandemic, there was no remodeling done to reflect a new modern work environment. So it necessarily means tenant improvements are going to be higher. And then one more piece I'd add is that there involves some corridor work, which we assess that as part of the TI work, even though it's separating two spaces.

Appreciate the color there, Rob. And then just going back to your commentary, maybe specifically on LA, it seems like, yeah, look, might be a little bit better, but obviously we've heard about the issues that the film and TV industry has had there. I know studios don't directly impact your business, but can you give us a sense, do you need to see an accelerated recovery within that industry to drive additional demand for office space?

Yeah, I think there's no question it would help. And as we mentioned in the prepared remarks, LA has been soft, but I think the team is doing a fantastic job of executing in a challenging market. And we are encouraged by what we're seeing in Long Beach, which has been consistent for some time, but we have seen some average deal size continue to ratchet up there, which is great to see. And new interest, I would say, in Culver City in particular, driven by both professional service and some technology tenants coming back to the market. So that's an encouraging dynamic as well.

Yeah, I'd add a couple more things, Michael. Governor Newsom over the weekend passed a bill that basically doubles the incentives for the film industry to film in California and specifically in Hollywood, and he signed that in Hollywood. So that's a move in the right direction because that's also been an issue where we've seen tenant activity in addition to Angela's comment about Century City, we've seen it pick up in Culver City and Beverly Hills as well. There's also a start of larger deal activity, at least looking in Playa Vista. So things are looking, you know, they're starting to turn the corner. And if you just look at our portfolio in LA, just to put it in perspective, because we have a smaller tenant market, We've executed 59 deals year-to-date, and that's almost 425,000 square feet. So our team in LA has been really busy. Smaller deals, granted, but our tour activity is up, and we're feeling pretty good about what we see going on in the competitive markets around us.

Our next question today will be from the line of Steve Sackbaugh with Evercore ISI. Please go ahead. Your line is now open.

Yeah, thanks. Good morning out there. Hi. Just to clarify, on the lease expiration schedule, I think you have three large known move outs in the fourth quarter. I just want to make sure that kind of implies something like a 90% plus, I guess, exit rate. So I just wanted to make sure that was right. And then as we look at 25, I guess, in Tony's question, outside of DermTech, is there any other I guess large known move outs that you're aware of today within the 750,000 feet expiring?

Yeah, as it relates to Q4, I think the biggest move outs will be cap one in San Francisco. Like we talked about, we got a couple extra months, which was one of the short term renewals reported this quarter, but that is a fourth quarter move out. We had the shorter-term new lease that was signed in the first quarter of this year, took occupancy in Q3, and will be a Q4 move out. That's around some short-term deals, around 100,000 feet of vacates in the fourth quarter. And then the Microsoft or LinkedIn lease in the Bay Area, which is about 76,000 feet. Those are the biggest moving pieces in the fourth quarter. As it relates to 2025, you appropriately point out both the DarmTech lease which is 110,000 square feet that will be moving out, you know, sort of mid Q1 of next year. And then the other larger lease within the, or the other largest lease within that expiration pool next year is also a Q1 expiration of about 80,000 feet. And we're in discussions now. I would expect it's a vacate or it's a significant downsize.

Okay, great. Thank you. And then as it relates to KOP2 and just the delivery of that project, I guess moving from, you know, the under construction perhaps into the tenant improvement phase, will all three buildings in phase two kind of move together or because they're in different sort of phases of their life, you know, will they move in phases, if you will? And so I guess what I'm trying to ask is will the capitalization be more of a phase for that or will it be kind of an all or nothing?

It'll be pretty close to together. I mean, Jeffrey's comments intentionally said it will predominantly occur in the fourth quarter of 2025. You know, one of the buildings might slip to base building completion in the first quarter of 2025, which would push, you know, the interest capitalization clock to stop in the first quarter of 2026. But you're talking about potentially a one-quarter difference.

Our next question today will be from the line of John P. Kim with BMO. Please go ahead. Your line is now open.

Thank you. On the land sales of $150 million in proceeds, can you discuss what the earnings impact may be? I think you're going to have some capitalized interest coming off. I don't know what the book value of the land is, but if there's going to be a gain, are you going to include that in earnings and timing? Do you expect this to be realized in 2025?

Yeah, I'll say a few things and then Elliot can jump in if there's any other color he wants to add. I would just say as it relates to the earnings impact in 2025, I just point back to Jeffrey's remarks. Not all the parcels in the future land pipeline are being capitalized. Some are, some aren't. Timing and what plans we're ultimately working towards in each of these parcels will matter. We need a little bit more. We're pointing it out as something that is worth consideration, but we need a little bit more time to progress some of these potential dispositions and refine our plans before we can get much more specific on what that means for 2025. And Jeffrey's comments highlighted just directionally, you know, I would expect capitalized interest to be a little bit lower in 2025. So that's the first piece. I would say, you know, I think based on the deals that are furthest along, we would expect some gains. in that portfolio, but we would not expect those to be gains that would be recognized through FFL.

And then as far as timing, since we are talking about a re-entitlement process, this is going to take quite a bit of time and it is tough to predict exactly how long. it will take, but you shouldn't expect anything before kind of the end of 2025, but we would expect these to happen in phases with the end of 2025, 2026, and potentially some in 2027.

Thank you for tackling the multi-part question. My second question is on KOP2, just going back to potentially signing traditional office users or tech users. How does that impact the cost or the expected yield of the project if you have to convert that lab space back to office? And does that impact leasing at all? Do you expect biotech or pharma users to be kind of turned off if there's a corporate tenant in there?

No, I think it all comes down to scale and sort of how the campus kind of comes together overall. I don't view leasing to you know, some office tenants as being an impairment to the rest of the campus. We certainly didn't experience that on phase one. I would say as it relates to any, I think your question is alluding to whether or not we have costs we've expended on the project that would really have to be demolished or pulled out in order to accommodate that use. We don't on two of the three buildings. Remember, we've only really built out the lab space for the spec suites in one of the three buildings. So there's plenty of vacant space and sort of shell condition that could accommodate those other users. To speak more specifically about overall deal economics at this point would be premature.

You know, the last thing I'd add to that is that both CITO and Stripe cohabitate, and it works really well. So, as Angela said, we've got a lot of space that can be used as office that's in shell condition, and we have spec lab space that's intended to be spec lab space and not converted back to office.

The next question today is from the line of Dylan Brzezinski with Green Street Advisors. Please go ahead. Your line is now open.

Good morning, and thanks for taking the question. Obviously, office capital markets are challenged today given an overall lack of debt availability, but it seems like things are improving on the leasing front, and hopefully that ultimately translates to a better capital markets environment. As you guys sort of look at the existing operating portfolio today and the sub-market positioning, is there appetite to eventually pare down the portfolio and sell out of sub-markets that you guys no longer deem as core?

Yeah, I think all of our plans as it relates to market positioning and sub-market positioning are things we're actively talking about. As we've pointed out, the transaction market's been really, really slow this year. You know, executing on anything has been more academic than something we can really do in practice. But we're thinking about the portfolio holistically all the time and trying to make sure that we're putting ourselves in a position to continue to move the portfolio in directions that we think will do the best job of helping us build a durable and resilient cash flow stream with significant growth in the future. And so that's how all of the potential dispositions and acquisitions will kind of be viewed through that lens.

Appreciate the comments, Angela. And then maybe just a small one on the acquisition. You guys talked about a low double digit stabilized yield. But given the near five year wall, is it safe to say that the sort of going in yield is close to that or are there sort of below market rents that is sort of bringing you guys that low stabilized double digit yield?

So Dylan, this is Elliot. Two comments. One, we think the rents are below market today. And two, as Angela mentioned earlier, we think this is sort of a mid-teens IRR. So we don't think this is sort of a you buy it and it deteriorates over time. That is not our expectation.

Our next question today will be from the line of Caitlin Burrows with Goldman Sachs. Please go ahead. Your line is now open.

Hi, everyone. I think Angela, back in the prepared remarks, you gave some commentary on the sublease market in San Francisco, how it's becoming less competitive or at least a large portion of it. Wondering if you can talk a little bit more on sublease space more broadly, but then in San Francisco, kind of how competitive is it? And are you seeing that kind of detract from conversations that you or other landlords might be having on direct leasing?

Yeah, I'll start and then I'll turn it over to Rob. As you pointed out, and I'll just reiterate kind of what we said earlier, which is it has been very competitive, you know, over the last couple of years, especially given where the demand has been coming from in terms of tenants, particularly in the AI category that are more startups that are looking for space that they can occupy very near term and just don't have the time, resources, capacity So really think about a long drawn-out build-out process for space that they hope to grow out of in a few years. So the sublease spaces really fit that need. But as we get closer and closer to those expirations, I would say when you look at the overall sublease market in San Francisco, you've got a combination of some of that space just kind of being obsolete, some of it being very large format or full floor uses, and that doesn't really meet the need for some of the tenants we're talking about, particularly in AI. And then you layer on this dynamic, which is that over half of the total sublease space in the market has a pretty near-term lease expiration. Every day that passes, that space gets less and less competitive. Those tenants just don't have long enough in the space to really be able to get enough out of it. So I think the team's doing a great job at making sure we're in front of some of those tenants that do have those more near-term requirements that maybe had been focused on sublease space, but really You know, encouraging them to look at the sublease space we have in the market and thinking about how we can position that most attractively to capture some of that demand, given all of those dynamics and where things are headed going forward.

Yeah, just a little more color, Caitlin. I think that if you look at in San Francisco specifically on sublease space, a lot of the forming young AI companies want short term, but they're looking for three years, often not less than that. And to Angela's point, as sublease space continues to get absorbed, which it is, projections are conservative that by 27, the vacancy rate should be at a more normal level, somewhere between 10% and 15% for San Francisco, with some of the former sublease space converting to direct space. I'd say in our other markets, it's sort of the same thing. In Seattle, for example, there's probably 15 to 20% of the market is sublease space, but you also have to look at what the term is in that sublease space with the shorter term being a little less attractive than the longer term. And so it's feeling like we are, you know, knock on wood that we just keep seeing tenants now have stopped putting space on the market and they're in a stable mode and that space is getting absorbed.

Got it. And then maybe on the other side, Angela, you did...

Sorry, one other comment I'd make on sublease space in general, when you look at 35% availability in San Francisco is a lot of that space is not competitive with us, meaning it's inferior, older product. Depending on the location and with the physical attributes, it may never lease its office.

Yes, got it. And then on the other side, Angela, you mentioned how some of those users are not necessarily looking for full floors of space. I think last quarter on the call, though, it did come up a number of times about how there were some large lease requirements in the market. Obviously, since then, we saw a big open AI lease. But as you think about the types of users that are out there, was that kind of what you were talking about with the large requirement last quarter? Or might there still be other requirements that you're hearing about for San Francisco for large spaces?

Yeah, no, I wasn't actually referring to the open AI lease that was in the market, though we certainly had visibility and were aware of that transaction. We were talking about a number of other larger deals that were coming to the market. I'd categorize larger in that case as more in and around 100,000 square foot range, and that activity does continue.

There's about 200,000 more feet of pending technology leases that are larger format that should be completed this quarter or early next year.

Our next question will be from the line of Tom Catherwood with BTIG. Please go ahead. Your line is open.

Thank you. And starting with Angela, following up on the sublease versus direct question, you had mentioned in your prepared remarks Kilroy expanding its spec suites offering to meet demand for more direct space from tenants. Beyond the spec suites that you're building at KOP in Phase 2, how much are you looking to add in other markets and what type of upfront investment does this require compared to traditional office TIs?

Yeah, look, we're leaning in a little bit, but I want to be clear as I was in my prepared remarks that this is, you know, sort of a leveraging, a thoughtfully executed and well-designed program the company has had in place for some time. I don't think this is a significant departure, but there are markets based on where we're seeing demand. In particular, in San Francisco, given new business formation, particularly on the AI side and what their requirements are, then it makes sense for us to do a little bit more on the spec suite side. We're probably talking about an inventory increase of a few spec suites at any given time. This is not like a major strategic shift. But hopefully what you take away from that is just we're being very thoughtful and very aware of where the demand is coming from in each of our markets and trying to figure out how we can position ourselves to capture as much of that as possible.

Got it. Appreciate those thoughts, Angela. And then second question for Elliot. On the land sales, given the conclusion that certain parcels have the potential for higher and better use, are you working on re-entitling those assets in order to maximize value? And is that contributing in any way to the sales timeline?

Short answer is yes, but what we've tried to do is work with groups, work with identified groups so that we are not re-entitling it in a vacuum, and that contributes to the timeline that we discussed.

Our next question will be from the line of Ohad Bregman with Deutsche Bank. Please go ahead. Your line is open.

Hi, good afternoon. This is actually Tayo from DB. Just wanted to talk a little bit about this upcoming debt maturity. You kind of have some chunky debt maturing each year between 2024 to 2026, that's been a pretty attractive interest rate. Just kind of given what capital markets are, what pricing is today, how do you kind of think about refinancing that debt and what potential kind of earnings drag, if any, could come from that?

Hi, this is Jeffrey. So at the end of the quarter, we had 1.7 built in of liquidity. And as I commented in my prepared remarks, we'll have cash on hand after we retire the maturity in December. We look at the 25 expiration schedule. It isn't until October that that bond actually matures. So given the amount of liquidity and flexibility we have in the interim, we're going to be pretty opportunistic about when we access capital markets in 25.

yeah but as jeffrey's pointing out the company had effectively pre-funded the maturity this year and has cash on hand to meet that need thank you thanks our next question will be from the line of peter bramowitz with jeffrey's please go ahead your line is now open

Yes, thank you. Most of my questions have been answered, but just wanted to ask one on availability at Indeed Tower in Austin. Could you just speak to demand overall in the market, specifically on the space you have left there to lease, just in terms of the depth and interest in that space?

This is Rob. Activity at Indeed Tower remains very consistent. We have some tenants that we're close to signing I don't want to get into more detail but you know we have the last block of really good space in the CBD that's manageable I mean there's other space on the market that's subleased that's much bigger block and landlords are going to hold out for that so as we've said kind of throughout the year demand in Austin has picked up particularly in the CBD and you're also starting to see some tech moves in the market out in the domain where IBM has signed a lease and others are following. So it's just taking time to finish that last piece, but we have some things in the pipeline that we hope to announce pretty soon.

All right. That's all for me. Thanks.

Thank you.

Thank you. And with no further questions in the queue, this will conclude the KRC 3Q24 earnings conference call. Thank you to everyone who was able to join us today. You may now disconnect your lines.