Kilroy Realty Corporation (KRC) Q3 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Q3 2015 Kilroy Realty Corp Earnings Conference Call. My name is Caroline and I'm your event manager for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of the conference. [Operator Instructions]. As a reminder, the call is recorded for replay purposes. And now, I'd like to turn the conference over to Mr. Tyler Rose, Executive Vice President and Chief Financial Officer. Please go ahead, sir.

Good morning, everyone. Thank you for joining us. On the call with me today are John Kilroy, Jeff Hawken, David Simon, Heidi Roth, Mike Sanford, Rob Paratte and Michelle Ngo. At the outset, I need to say that some of the information we will be discussing is forward-looking in nature. Please refer to our supplemental package for a statement regarding the forward-looking information in this call and in the supplemental. This call is being telecast live on our website and will be available for replay for the next seven days both by phone and over the Internet. Our press release and supplemental packages have been filed on a Form 8-K with the SEC and both are also available on our website. John will start the call with a review of the third quarter. Jeff will discuss conditions in our key markets. I will finish up with financial highlights and review of our updated 2015 earnings guidance that we provided in yesterday release. Then we will be happy to take your questions. John?

Thank you, Tyler. Hello everyone and thank you for joining us today. Let me start by addressing the recent articles and questions related to this strength of the tech sector generally in the San Francisco market specifically. While we are always on the lookout for signs that the real estate market is changing for both, the good and the bad. We currently see nothing on the ground in our discussions with tenants and business leaders or in specific real estate statistics that suggest that the cycle has turned. UCLA Anderson or [Indiscernible] are forecasting two more years of expansion. Revenue producing technology companies continue to grow and benefits from the proliferation of the internet and mobile devices and West Coast real estate market continue to build strong momentums, with fundamentals improving at all of our submarkets including San Francisco. Quarter-over-quarter we saw demand increase for large blocks of space due supply state limited and rental rates continue to rise. Sublease space sale in San Francisco and Silicon Valley had tenure high in absorption. And our discussions with the executives of large technology companies about their internal studies on headcount, they note that San Francisco and Seattle remain the top markets in the U.S. for attracting talent. We see this in recent reports on tech job openings which remain robust. San Francisco reported over 3,500 tech jobs to fill. Seattle reported almost 3,000 and Los Angeles reported more than 2,200 tech jobs openings, we also Google, Microsoft, Apple, Amazon and other three reports stronger than expected earnings. We don't want to sound Pollyannaish [ph]. We acknowledge that our risk to the current economy and we are mindful of the imports of venture capital funding to the tech industry particular the start-ups. We just started seeing deterioration in the fundamentals. In fact the level of demand both in Silicon Valley and San Francisco has never been stronger as evidenced by the data. San Francisco had 1.5 million square feet of net absorption so far this year with another 500,000 square feet projected for the fourth quarter. There are currently 26 San Francisco requirements of over 100,000 square feet up from 15 last quarters, and only two spaces of that size are available. Silicon Valley has already had one of its strongest absorption years with projections for very strong fourth quarter. And we're seeing demand increase in all of our markets. In San Francisco demand increased from 7.8 million square feet in the second quarter to 9.2 million square feet in the third quarter, an 18% increase. Silicon Valley demand increased to 9.4 million square feet from 8.2 million square feet in the second quarter, a 15% increased. Seattle increased about 25% to 30% third over second quarter. With those strong market conditions we made solid progress during the quarter. We wrote new renewal leases on 385,000 square feet of space in our stabilized portfolio putting us just over 1 million square feet year to-date. We are now 95.6% occupied and 97.2% leased. Rents on our third quarter leases were up 39% on a cash basis and 53% on a GAAP basis. We also have approximately 400,000 square feet letters of intent outstanding in our core portfolio. On adjusted basis we produced year-over-year increase in cash same-store NOI of 5.4%. We deliver 100,000 square feet of office space to NeueHouse or Columbia Square mixed-use project in Hollywood. We completed the acquisition of 100 Hooper Street, the last fully entitled to shuffle development site in San Francisco for 78 million. We effectively settled all remaining outstanding issues with our surrounding neighbors regarding the development of our one for sale, mixed-use project in Del Mar, and are moving ahead on entitlement in design. We completed the sale six non strategic properties in San Diego for gross proceeds of $163 million. We completed the sale of $250 million of equity to help fund our current development program. And we issued $400 million of 10 year bonds to replace maturing debt and maintain the strength of our balance sheet. We also continue to make progress on our development program. In addition to delivering the historic office space at Columbia Square last quarter to NeueHouse we completed and delivered the first building at our Crossing/900 project earlier this month. We expect to complete and deliver the second building in early November. That two building 339,000 square foot office property located in Downtown Redwood in the heart of Silicon Valley is fully leased the box. We commenced construction just two months ago. On our exchange in 2016 project our 700,000 square foot development project in Mission Bay. We have negotiations and have significant interest from a variety of tenant prospects, both tech and non-tech. Of the roughly 2 million square feet plus of interest for this facility approximately 60% is non-tech. And I might add that the demand numbers I gave you on San Francisco don't reflect a shadow pipeline where we've NDAs with several people that represent millions of square feet beyond that 9 point somewhat million square feet of current demand. So we think things are very shaping up very nicely for the exchange. So we anticipate and we're confident that exchange will be substantially leased well before completion of construction which is not scheduled until the third quarter of 2017. In earlier this month, cash [Indiscernible] phase 1 at our 350 Mission Street project, the 450,000 square foot, SOMA office tower is fully lease to sales force. Tyler will discuss revenue recognition latter on the call. With regard to our near term development pipeline our four projects remained extremely well positioned for potential starts next year. First is 100 Hooper Street, as we have previously discussed we can start construction at any time, but we're likely wait until we have executed significant portion of leasing on the exchange or on Hooper itself before we break ground. Since acquiring the site three months ago, we're in early stage discussions with a handful both tech and non-tech prospects any of which – any one of which could take substantial in/or majority of the project. Second is One Paseo in Del Mar, our mixed-use development project that will bring much needs contemporary office, residential and retail space to the very fluent neighborhood of Del Mar. We've made significant strides this year with our neighbors and community groups to settle all the issues unless move forward on the approval process and we anticipate being able to construct – start construction mid next year of one or more phases depending on market conditions. Finally, the near term pipeline includes the academy on Hollywood and 333 Dexter in South Lake Union, both projects locate in strong and vibrant markets. We expect that final approvals on both projects by the end of second quarter. Taken as whole these four projects represent a near term development pipeline with a preliminary estimated investment of approximately $1.5 billion. Looking further out we continue to make progress on expanding and designing world-class destinations, the Flower Mart, San Francisco we've recently completed the acquisition of half acre site to add to our development plans, subject to final entitlements and market conditions. We expect to commence construction of approximately two years and estimated total investment to be slightly over 1 billion including land. In total, our overall development pipeline acquired very attractive basis provides the tremendous opportunity to create value over the next several years. Each project is distinctly situated in higher desirable submarkets that provide the infrastructure we seek including public transportation, retail, residential and entertainment amenities as well as communities that embrace historical or iconic elements. Turning to dispositions through the end of the third quarter, we completed the sale of 10 building encompassing more than 1 million square feet of space in a land site in Orange County for total gross proceeds of 335 million. That puts us at the high end of our projected dispositions for the year. Both with investors showing strong long growing interest and acquiring commercial real estate and the continued disconnect between public and private valuations, we continue to look at additional opportunities to sell non-strategic assets and recycle capital into higher value creating opportunities. We are currently working on another relatively large disposition transaction that will likely close in the first and expect to have more detail to share on this front on our next call. Well broadly as I said earlier, the fundamentals across our markets remained. We believe the markets we operate in are uniquely attractive growing companies, given their access to talent, public transportation in cultural and lifestyle benefits that appeal to a generation of [Indiscernible]. We are taking nothing for granted and our sale grew with regard to the cyclicality of our business. We have operated in West Coast markets for more than 65 years through multiple cycles. And our track record as a public company shows that we develop when it make sense, we acquire when it make sense and we just manage our core portfolio when that makes the most sense. We will continue to operate with this investment strategy. On the operational front we remained focused on our top priorities that leasing, capturing and better rent growth on time and on budget construction and financial strength. With that, I'll turn the call over to Jeff for review of our markets. Jeff.

Thanks John. Hello everyone. Economic conditions across all of our markets remained strong. California continues to add jobs at a robust rate and forecasters now project the state's job and GDP growth will consistently outpaced the U.S. through at least 2017. A summer store is unfolding in the Greater Seattle area where unemployment has now hit an eight-year low and job creation continues a rapid clip. Let's take a look at real estate fundamentals in each of our markets starting San Francisco. San Francisco Bay area continues to outperform most other U.S market with strong demand and a limited supply of large blocks at commercial space. Sublease space decline in a quarter to 1.2 million square feet or 1.6% of the market down from 1.6 million square feet in June or 2.1% of the market. Class A direct vacancy remains effectively 0% in the SOMA district and 8.4% in the south financial district. Silicon Valley had a very strong third quarter with over 1.6 million square feet of absorption. Tech expansion has driven Class A vacancy rates in the region excluding San Jose down to 3.6%, lowest in almost a decade. We are currently 98.6% leased in the Bay area and our in place rents for the region are approximately 32% below market. In greater Seattle strong demand has pushed asking rents to their higher level in almost a decade. And our primary Seattle submarkets are Bellevue and South Lake Union Class A direct vacancy rates are now about 5.6%. In Downtown Bellevue sales force recently announced, it would double its workforce and triple the amount of its leased office space. Our Seattle portfolio is currently 87.4% leased and our emplace rents are approximately 10% below market. In our San Diego market, steady business expansion coupled with limited amounts of new commercial office space continue to drive rental rates higher. There have been 11 new Class A leasing transactions greater than 20,000 square feet in 2015 after only three in 2014. In our Del Mar and Sorrento Mesa submarkets Class A direct vacancy rates are now 9.4% and 5.8% respectively. Our San Diego portfolio is currently 97.4% leased. Our San Diego emplace rents are approximately 7% above market. We are seeing strong rent growth in Los Angeles particularly in markets attractive to creative service, entertainment like Santa Monica, West LA, Beverly Hills and Hollywood. In West L.A. the Class A direct vacancy rate is 11.6% and in Hollywood it is 5.1% across our Los Angeles portfolio we are now 95.4% leased. Our emplace rents here are approximately 16% below market. Looking at our overall portfolio, we now estimate that our rents are roughly 15% below market. Remaining 2015 expiration total approximately 276,000 square feet with 200,000 square now expected to be vacated. This includes Qualcomm's recent announcement, they were not renewing their 68,000 square foot with us and through EMESA. That's an update on our market. Now Tyler will cover our financial results in more detail. Tyler?

Thanks Jeff. FFO was $0.77 a share in the third quarter. We ended the quarter with stabilized occupancy at 95.6% down from 96.7% at the end of the second quarter. As we previewed on earlier calls, our occupancy depth in the third quarter due to lease rollover in several of our markets, most of this space has now been released. Same-store NOI was up 5.4% on a cash basis, and 3.6% on a GAAP basis in the third quarter after adjusting for 2014 lease termination fee. We were active in the capital markets during the quarter, in July we completed the register direct placements of just under 3.8 million common shares to proceeds were approximately $250 million. And in September we sold $400 million of 10-year senior unsecured notes and a public offering on an annual interest rate of [Indiscernible]. The funds from these transactions were use to fund the $78 million acquisition of Hooper Street and the repayment of two maturing mortgage totaling $90 million. We will pay up 325 million of maturing bonds next week and use the remaining proceeds to fund development spending. Taking all these transactions into account we will have $100 million loan restricted cash after the pay off of the bonds and full availability on our $600 million bank line which expandable to 900 million. Now let's discussion updated guidance for 2015, so again, let me remind you that we approach our near term performance forecasting with a high degree of caution given all the uncertainties in today's economy. Our internal forecasting and guidance reflects the information and market intelligence as we know it today and a significant shift in the economy, our market tenant demand, construction cost and new office supply going forward could have a meaningful impact on our results in ways not currently reflected in our analysis. Projected revenue recognition dates for new development are subject to several factors that we can't control including the timing of tenant occupancies. With those caveats our assumptions for the remainder of 2015 are as follows. As always, we don’t forecast any potential acquisitions or acquisition-related expenses. We anticipate remaining 2015 development spending on our seven projects under construction to be approximately $150 million. On the development delivery front, as John mentioned we deliver the first building across 3/900 in Redwood City in October and expect to deliver the second building in November. While we had anticipated that we will recognize revenue on our 350 Mission Street property in the fourth quarter given tenant delays and completing TI work, we now anticipate revenue recognition to commence in phases starting in January with stabilization expect in the second quarter. The change of timing has no impact on cash rents as sales force begun paying rent on about 20% of the building earlier this month. Our core portfolio assumptions are as follows. Given our continued strong same-store performance we are increasing our projected 2015 cash same-store NOI growth to a range of 3.5% to 4% on adjusted basis. We're lowering our projected year-end occupancy to approximately 84% driven by Qualcomm decision not to renew 68 square feet in Sorrento Mesa. We expect occupancy to be backup to approximately 95% by the end of the first quarter. And we now project a 2015 SAD payout ratio approximately 70%. To sum up, last quarter we provided 2015 FFO per share guidance of 330 to 340 increasing our midpoint $0.03 to 335. This quarter given strong projecting revenues of roughly $0.04 partially offset by the delayed revenue recognition totaling $0.015 of 350 Mission, we are again increasing the midpoint of our 2015 FFO guidance by $0.03 to $3.38 per share and tightening our range to $3.36 for $3.40 per share. That’s the latest news from KRC. Now we’ll be happy to take your questions, Operator?

Thank you. [Operator Instructions] Please standby for your first question. And that comes from the line of John Kim from BMO Capital Markets. Please go ahead.

Thank you. Good morning. Looks like you have an additional 945 million of funding remaining on your current and near term development pipeline spread out over a few years. Will the expected as a sell proceeds next year be enough to fund your commitments next year on a leverage neutral basis?

Well it depends how much we sell of course, but let me – I'm not going to give you. I'll give you a range. We've sold 400 million around number this year. We already have about two-thirds of that in the bag for early next year. And I think we'll increase that substantially, it could be number of multiples to that. So I think we're going to do just line on our funding.

This is Tyler. I'll comment on leverage neutral, as you know, I mean our leverage is very low, debt to the capitals in the mid 20s that total assets is probably 30 or debt to EBITDA is now down to at the end of the year into the low mid 60, so we have that capacity as well.

John, on the large disposition that you reference, can you provide any commentary on what market it’s in and whether not it’s a developed asset or an asset you acquired?

I choose not to do that. We have a confidentiality agreement with these people. They don’t really allow us to talk about. So I've got to honor that. But if we have sign purchase to sell agreement, they are just completing their due-diligence and I'm very comfortable with the transaction.

Okay. On the tenant improvement cost, look like they were above where they were last year. Is this a function of more San Diego space expiry year and now you surprise by the stickiness of tenant incentive?

Tyler or Jeff.

Yes. I don't think there's anything that's really driving that. I think it’s just the function of what properties Gulf releasing and what the market is for the tenant requirements. So it’s not really a trend or anything that sort of year-over-year this striving that other than this specific tenant improvements of any given building.

So the rental are increasing, it’s getting high releasing but the GI is still pretty high?

I think generally speaking again it’s based on its particular space but again we're seen really good spreads on the rents and I think that the tenant improvement, concessions are certainly down in terms of free rent pretty much across our markets, so it’s really just a function of tenant improvements.

Okay. And then my final question is [Indiscernible] and if you can provide any commentary on how they are operating as far as their own occupancies and if you have any appetite expand with them in other markets?

I'll do it. Go ahead David.

No. I can take that. So they are open in operating in Hollywood and they have very deliberate space on how other member should work there hitting or meeting their expectations and coming and had a huge line of potential membership [Indiscernible] even opening show the space is great. They are often running to a great start in a Hollywood project.

This turns the other part of expanding in the other markets, they would like to expand -- in other markets, so we're going to look at each of those individually to what make sense.

Got it. Thank you.

Thank you. The next question we have comes from the line of Craig Mailman from KeyBanc. Please go ahead.

Hi, guys. John your comments were helpful [Indiscernible] but I'm just curious as you guys look to lease up exchange in 2016 and kind of get interest on a 100 Hooper. Is your underwriting of tenant credit changing at all you guys trying to maybe filled up with more non-tech type tenants the go round?

Well, I can't – again, we have a bunch of NDAs on that property with just about every tenant we deal with. Now if substance requires you sign on NDA, so we can't really disclose who they are, but the tenants still are working and there are several of them of the 1.2 or 1.3 million square feet it’s not tech, all of those transactions are very, very long leased terms with extremely credit and it is our goal to make those transactions and I think we will. I'm very comfortable we're going to make – we can't make all of them because we don't have enough square footage. But I will say that non-tech tenants will take a lot longer than tech tenants to get deals done with.

I guess, but the way you are looking at tech credits these days are you guys scrutinizing it more or less than you know 6 to 12 months ago?

I think we were very thorough in scrutinizing tech credits six months ago and a year ago and two year ago if you look at some of the tech tenants that were smaller we had mass of loads of layers of credit. And we had great comfort that the buildings because the buildings were designed by us for unknown tenants as opposed to designed specifically for a singular tenant. So we feel -- felt very comfortable that we had assets that would perform well. There was a pick up with a tenant and we had tremendous credit support. So our underwriting I think has been very thorough throughout this cycle. We have not done deals with some of the tenants that we thought didn’t have great credit where we had the opportunity and we will continue to be to show our scrutiny with regard to our financial review of our customers whether they are tech or non-tech.

That’s helpful. Then I guess as you guys walk the space these days particular on the tech side, what does the utilization look like?

Almost, they are just packed in. I mean, Rob you want to comment. I mean you make with all of our tech tenants and all of our tech prospects as well as non tech on a regular basis.

Sure, good morning everybody. We do need as John said on a regular basis with all of our tenants as well as prospects and these are well established national and multinational companies and they have very deep real estate teams that do nothing but study headcount. And as John said earlier, the exchange with a couple of the tenants we’re talking to, it’s not going to be a quick decision at the snap of the finger to take half a million square feet as an example. So I think caution has actually been exercised by these companies from 2012 on. It’s not a new phenomenon in terms of them acting in a more pragmatic and slow method. And I do feel that they are busting at the seams with all the planning and all the staff they put in, they have been undershooting the space needs they have. So in the examples here in San Francisco that are well known there are a lot of companies that signed leases in June that are now looking for more safe.

That’s helpful.

Sorry, and I other point I’d like to make is that there are -- we are talking to several companies that are having needs that are 2016 needs that they are literally I would say scrambling to try and fill now space needs. Once they get those buttoned down, those needs they have new needs rolling into 2017 and 2018 that are significant.

And then just lastly, could you guys just run through your mark-to-market expectations by market?

Yes I think I can do that. Jeff went through that in his comments I think. We’re 15% on the market as a portfolio, Francisco is 32 plus percent on the market, Washington is about 10% on the market, LA is about 16% on the market, San Diego is about 7% over the market.

Great. Thank you.

Thank you for that question. The next question we have comes from the line of [Indiscernible] from Morgan and Stanley.

Great. Thanks, so John you did a great job addressing the tech question upfront. One of the more positive things we’re hearing is that if VCs [ph] are less active it’s only because other investors are nudging them out with hedge funds and others now trying to invest earlier before the IPO for example which would be a good thing for leasing demand if funding sources are growing more diverse. Have you heard anything about how some of your newer early stage tenants are getting funded these days, do you still primarily hear about VC money backing them or are there any signs that it’s getting more diverse?

Rob [ph] I’m certainly not an expert on that and I will say this, we have tenants in our buildings like Capital One which look exactly like a tech company that took two floors at 201 Third Street and there in San Francisco looking like tech companies because they are funding tech companies. So you have to bank on that in a big way now and you have the VCs obviously in it in a big way historically and then you have some of the big tech entrepreneurs that are -- the household names that have made billions that are funding other tech companies in going around the VCs. They are going to have to [Indiscernible] their own VC I suppose. So the funding sources seem to be increasing. And I just want to point out something here, because frankly I’m a little frustrated with some of the articles that have been written by some of the people that are probably on this telephone call. I understand that we’ve had five years of terrific growth in San Francisco and Silicon Valley and four years or so in Seattle and with the tech sector. But there are other sectors that are growing tremendously. I wish I could you what, I know but I can’t on one sector because we have NDAs [Indiscernible] but I think that what we are seeing here is it seems like there is some hick ups when twitter said they are not proceed with a 100,000 foot lease and lay off 300 people or something or Zynga a year ago when they have had their problems and it’s a bad business model I suppose for them. These are the natural hick ups that we are going to see. But if everybody and every single tech company has to be doing terrific for people to write positive articles then by definition you can’t always have a positive article. The reality is I have never seen a market, where I have the broker I talk to or the people I work with here that have long time been in San Francisco and Silicon Valley never seen markets stronger than they are today, never seen demand greater than they are today, never seen a supply imbalance greater than it is today, on the positive side maybe lack of supply. There are two major things that are going on. There is a revolution in technology where if this is the industrial revolution it be 1900. Think about the disruption that’s going on. I think Andreessen the famous VC investor said very well several months ago. New technologies are debarring [ph] entire industries. It’s happening at all different levels. Cyber securities, medicine and technology which is in its infancy, technology and media, active wear and wearable’s, thin tech, meaning financial tech which is in part here to your issue about financing is that major financial institutions banks and so forth are buying these start up financial entrepreneurs that are in the technology side because they can’t develop this creativity themselves. That is exploding and automobiles, driverless cars and movies and entertainment and energy almost every industry is transformed or will be by technology and we are in the early stages of it, and with that we are going to have some volatility. I think the way I would characterize is we’re going to have tremendous growth over the next several years and for many decades but it will be punctuated times with some volatility because we are not going to see every company or start up go to the moon. And you can tell I’m frustrated, most of me for long time. I have never seen such a disconnect with what’s being written by some, and what’s going on in the ground. And I care more about what’s going on in the ground

Okay. That’s great color. Thanks for the insight. And then just shifting gears for Tyler the G&A lines if they have a noticeable amount, anything unusual there, is that a decent run rate going forward?

Yes most of that’s related to our deferred compensation mark-to-market so a million dollars of that is showing up as a reduction and other income, so it doesn’t have any impact on the bottom line of FFO. So G&A is down, while the other income is down by roughly a million of that and it’s a little bit of other things in G&A that the G&A was down but most of that is related to the deferred comp.

Okay, that’s helpful. And then last one from me, back to somewhat John’s comments earlier, you alluded to the private demand remaining strong, can you give us any more color on foreign capital flows in the interest in your properties would you say it’s getting any more or less active with foreign capital looking for a home and is there any movement in cap rates worth mentioning?

Well I think -- the first to the first part of the question I have never had more people coming to this office that are foreign source of capital as I have in the last six months, never. Not in the rest of my life up until that time. Everybody wants to be in these markets and if you take a look at the couple of deals that we’ve just done, the most recent transactions of substance were the twitter buildings which went for roughly $970 a square foot and the Airbnb building which went for about the same. And I think if you applied those cap rates and those are our projections to our buildings, to most of our buildings which are rented at higher rents you will have value substantially in excess of that. There is a wall of money trying to buy both foreigners and others in this city and elsewhere and again I’ve never seen it to this magnitude.

Okay. Terrific. That’s it from me. Thanks guys.

Thank you for the question. The next question comes from the line of [Indiscernible] from Citi. Please go ahead.

Good morning, it’s actually Michael Billerman [ph]. John, maybe just teeing off of that and you talked about the disconnect between public and private market values and I’m just curious what your view is, what your stock, where it is today relative to the private market value of your portfolio?

Well I mean if you were to apply market values to -- you are not going to have the same cap rate applied to things in San Diego as you are to things in San Francisco, Silicon Valley. I think LA is demonstrating very low cap rates; it was just that the dearth of products that’s available down there. I am actually frankly surprised that some of the valuations in LA given where the market is [Indiscernible] and so forth. But, yes I think that the value is substantially higher than the market is valuing the company today, but I’m very confident that we will demonstrate some -- that’s leasing here on some of the properties that we just started construction on at block buster rates with block buster companies.

And then how do you balance and I recognize it is a balance, but raising equity at 66 if your belief is that the value of your assets is that dramatically above that -- selling equity in your company arguably at a big discount and taking that delusion obviously you are using it to fund accretive development. But just walk us through the thought process of doing that when you are so confident in the effort values and selling assets.

Well you mean you are talking about the 250 million we did earlier this year?

Yes, yes.

I mean just take a look at it. We are building to roughly 8% going plus or minus 8% going in ROICs. So, I think that the use of the proceeds speaks for itself.

And I also appreciate all your commentary regarding San Francisco outside of recent [Indiscernible] reports that you are talking about, where else do you sort of hear, it have to be emanating from somewhere, I don’t think we….

Michael, look what’s going on. The hedges play the tax and then they play the companies, the real estate companies that are public that do business with the techs. We all know what’s going on. The hedge fund industry is out of control in my view. That will be regulated; I’m not a big regulation guy. But, I’m talking about primarily about some of the analyst reports which I don’t think have been very thoughtful.

Not ours….

I won’t name names.

As long as it is not ours. Do you guys have any I mean you think about the affordability from a rental perspective, residential side in San Francisco clearly that’s getting a lot of your time in terms of people living you think what’s going on in Oakland [ph] and who we are going over there and trying to attract employee, I mean does it give you any concern at all in terms of the price inventory to attract talent and that talent being pushed out of San Francisco in that potentially affecting the residential market affecting the office market?

There is things called roads and ferries in part in -- and that’s how people get to work. The lion share of people that were in San Francisco don’t live in San Francisco. And the transportation and housing is a regional issue in just about every city in the world certainly here in the Bay area, you can’t deliver enough houses in San Francisco over the next ten years to satisfy the number of people that want to live here. It’s always going to be expensive to live here. But what you are seeing is a tremendous number of house of apartments being built in the city, you are seeing a tremendous number of apartments being build in Oakland, you are seeing them being built in other areas and people will come here via the transportation system. That’s why we’ve been such an avacor over the last six years of projects that are near public transportation. These cities don’t want cars, they want to use public transportation and it’s served with chicken and egg. You have to have public outcry that we need better public transportation in order to get people to pay for the bonds and so forth that finances it. Here in San Francisco they are talking about additional -- they have been acting on it. They have got the Trans Bay terminal under construction; they have got the Central subway that will connect BART and Caltrain that will start construction here shortly. They are talking about more BART to -- transportation always lags, but housing is generally going to be at the end of those transportation terminals, not that the city of San Francisco does not have the land area to build everything that needs to build.

And last quick one, are you changing your underwriting at all in terms of underwriting tech tenants or rather tenants either upfront deposits or any pre paid rent. Has anything changed in your calculus as you are renting space?

Well we -- I answered this question to somebody earlier in this call. We’ve always been -- as you show a lot of scrutiny and a lot of due diligence and we go through amazing amount of due diligence in our writing and with the CFOs and if there is -- capitals with them and we get huge letters on credit and we make sure that we have rents that are no higher than market or and that we have product that is not specific to any one tenant. So I would -- I’m not going to say that we are harder on people than we were before because we’ve always been pretty hard on tenants.

All right. Thanks, John.

You’re welcome.

Thank you. The next question we have comes from the line of Brendan Maiorana from Wells Fargo Securities. Please go ahead.

Thanks, good morning out there. Question I guess purely for John or Mike Sanford. So, I always felt like in the San Francisco market there was some risk that some of the early stage tech companies the funding model flows down a little bit, maybe they don’t grow as aggressively but the opportunity for the city in terms of a tenancy seem like it was from the large tech companies that are in the valley that don’t have a big presence in the city. Are you seeing much migration of those tenants into San Francisco that are looking around more now than maybe they have been there in the past?

Yes, hi it’s Mike Sanford. Good morning. We’re definitely have been seeing migration from the valley in the San Francisco. It’s all of the things that John has been talking about for years. Folks want to be in the cities especially when the workers live here in urban environment. But I think what’s really compelling about this the statistics is not only is San Francisco extremely strong this is the fifth year in a row of over 1 million square foot of absorption. It’s not a one head wonder; it’s been consistent year-over-year. But I think what add to that is the fact that the valley is also extremely strong. 1.6 million square feet of absorption in this quarter which is more than San Francisco for the entire year. The vacancy rate down there is as you heard earlier in the call excluding [Indiscernible] under 4%. All of the key markets we are in are near 0% to 1% vacancy from a Class A standpoint. And what you are seeing is a classic demand supply and balance. You heard us talk about the stats, how many tenants looking for over 100,000 square feet, how little supply there is. But those numbers are only a sort of part of the story. There is actually more demand than is being reported as John discussed. We know tenants are in the markets that aren’t on those list. On the flip side is actually a less supply. To a lot of the tenants that are absorbing this space are mostly going to Class A space and leaving space that is practically functionally obsolete for today’s users. So the numbers are even better than what we are seeing in the statistics, and that strength in both sectors of the Bay areas is the foundation for growth of the future.

And Mike maybe just as you are looking at rent growth on a four basis maybe over the next year or so, kind of what do you think -- what are kind of the best expectations of forward rent growth and how does that compare to maybe where it’s been over the past year or two?

Well just before Mike does, guys, I want to make it real clear that our underwriting on the exchange, our underwriting on 100 Hooper, our underwriting on the future flower mark has all been done at rates lower than what is currently in the market today. We are very conservative in our underwriting. Lots of contingencies, lots of expectation and generally we’ve been way over estimating what cost increases might be and so forth, but Mike will add..

Yes, so historically you’ve been seeing double digit rank growth both in the valley in San Francisco and if you look at what we’ve seen year-to-date you are on pace for over 10%, again that 10% to 15% range of both markets. As John said, we are more conservative as we project out and looking at rent growth when we underwrite. But I think the other important point to note is even though rents now are roughly at where they were during the 2000 cycle there is so much more density in the spaces today, right. John talked about this for years and so from a cost per employee perspective rents are actually down. And I think that’s an important characteristic to remember when you see rental rates on a per square foot basis today has been sort of a paradigm shift and how people are using space and they are using it more densely and we are providing the -- and exiting and the like and the elevator so and so forth to support that density.

Okay. That’s great. And then just last one maybe for Jeff or Tyler. So you guys mentioned that year end occupancy down to 94% because of Qualcomm, I think it was 94.5% last quarter. Where were some of the given that you are around 95.5% now, where were some of the other tenants that were expected to roll to drive occupancy down by year-end given that your lease rate is substantially higher than that?

Yes well from the second or third quarter the roll over there was spread fairly evenly about a third in San Francisco, third in Seattle and third in LA approximately. From the third or fourth quarter most of it is in San Diego. I think it was 160,000 feet and 130 of that in San Diego and 30 of it is in Seattle.

Okay, great. Thank you.

Thank you. The next question we have comes from the line of Nick Yulico from UBS. Please go ahead.

Thanks. Just going back to the exchange development. Can you talk some more about why guys wanted the optionality of doing I think 50:50 office life science for the project, and going back to over a million tenants that were non-tech that you said they were working on exchange our life science tenants considered non tech?

We’re not talking any life science tenants right now. I mean we have -- we’ve had discussions but that’s not in my calculus of square footage that we talked about. With regard to our decision, what we did is we wanted to make sure we had the height floor to floor and that we had the structural capacity to handle a broad range of tenants whether it’s life science or whether it’s something else. And so we made that decision to incorporate that into the building we thought that was a good long term investment because we always look and we’re building buildings at locations that are irreplaceable that are world class design and that are lead platinum and the best in class and we look at these as assets that we get on for the next 100 years. They are certainly going to perform well whether we own or if somebody else for hundreds of years not for 20 years. So we are a lot different than the merchant builder that simply looks at how do you build it, kind of get away with it as cheaply as you can, lease it and flip it. We’re the absolute opposite.

Okay, so at the end of the day I mean do you have, do you envision half of that project being life science or is it…..

No, I said no.

Okay. And then I think Ross had a follow up question.

Yes, hey John.

Hey Ross.

Can you talk a little bit about the one for sale; let’s get out for [Indiscernible] sale.

Good.

You got a 178 million in there. I went back in your supplemtal from 2011; you had 120 million into the project four years ago. So, I guess the question is having watched 58 million go in over the last four years, reasonably speaking what should we all be expecting for return given the pretty serious carry cost there?

Yes we are forecasting in the high 6 percentile or high 6s and we made you better than if that’s unsterilized our see unlevered and remember about half of that as apartments.

And is that on kind of current rent, are you making any assumptions that market rents is going to keep going up by the time you deliver?

I believe it’s on current rents David.

Yes, it’s the office is on current rents, the retail product that we’ll be developing will be pretty unique down there, so we feel pretty good about the attractiveness of that and a lot of interest in that and the apartments are in the current market rents.

And at this point in time you are going to do the whole thing on your own or you going to [Indiscernible] .

We haven’t decided.

Thanks John.

You’re welcome.

Thank you. The next question comes from the line of David Rodgers from Robert W. Baird. Please go ahead.

Yes morning guys. Jeff, first question for you or maybe Tyler but with regard to the 160 basis point I think differential between lease and occupied, any meaningful kind of chunks of new leasing that we should expect to kind of come in through those numbers and kind of timing on that, if you can give us that?

As I mention I think, we expect most of that releasing will come in by the fourth quarter but most of it is in the first quarter, so by the end of the first quarter we are projecting to be back to 95%. And some of that’s in San Francisco at [Indiscernible] second until one third in Seattle.

Okay, that makes sense. And then with regard to the kind of tenant reimbursements in the quarter they seem to be a little bit lower off this quarter. Is there anything unusual or unique in that that we should be thinking about?

No I think it will revert back in the fourth quarter. There were some basic resets, some kind of payments, prior year refunds that came through in the third quarter that caused reimbursements to be a bit lower but also expenses were a little bit lower. So if anything -- odd numbers or $0.77 it would have been even better than that for some of those factors, but we’ll be back to normal, we project we’ll be back to normal next quarter.

Okay. And then John a question for you on 350 Mission I think you said that the movement was a little bit slower there with actually the build out issue and I guess just a broader question, are you still seeing a pretty good take up of space as you are completing the tenant space through development, re-development or just through kind of second gen leasing. There’s a pace at which tenants are kind of filling that space up and I guess do we make any co-relation from the 350 Mission slowdown?

No 350 Mission is because they changed two was going to occupy the building. You now have the senior management, the Chairman and President and all that stuff taking the top three floor and they have hired a different architect than the one they were using before and have slowed it down.

Okay. Great, thanks.

Thank you for that question. The next question comes from the line of Jamie Feldman from Bank of America Merrill Lynch. Please go ahead.

Great, thank you. Can we focus on 333 Dexter for a moment and just talk about progress on the project and then maybe that’s the leasing pipeline?

Well in terms of the progress, we’ve gone through the initial steps for the City and submitting it so forth and we’re on line to receive approval I believe it’s right around the end of the first quarter of next year early the second quarter. So we are confident, they love our design and in terms of re-releasing and so forth. Rob, you want to handle that?

Sure. As with any ground up development that we do, we have a pretty robust preleasing and marketing program that we’ve started already. We will have and you guys will probably see them in different presentations upgraded videos and that type of thing that we are doing overtime, anticipating a second quarter construction start. And in terms of marketing I would say the thing that’s really most interesting about it is the level of interest that we’re getting from companies outside of the Seattle market in the project and it’s also been very well received just in terms of design and some other attributes which I don’t want to get into giving our secrets away, but we have local interest as well as outside of Seattle interest in the project already.

We just hired the broker last month.

Okay. And do you think it will be more of life science or office and what do you think about the relative returns of both.

I think it’s’ going to be office and I think it’s going to be somewhere in the neighborhood of what we’ve been achieving down here in San Francisco which is in that sort of high 7 to low 8 in …

Okay. And then did you give an update on the high Del Mar in terms of leasing progress?

No, we didn’t. David, you want to do that. Or Rob or…

Rob, you can handle it.

Sure. We’re really pleased virtually -- we’re virtually closed in now at the property. It’s unbelievable in terms of the landscaping and amenities that we have finished there. We have active discussions with about 200,000 feet of tenants, some are a couple of them actually are looking at the whole building and the rest are multi tenants and we expect to have some success to announce there soon. But it again, Del Mar is the best submarket in that San Diego county area and I think the it’s an amenity driven market and what we’re providing is just weeks above what I think you find in UTC and some of the more dense urban parts of San Diego.

Okay, so assuming you get leasing done, I assume it comes online not leased or not occupied, like when do you think it’s actually…

Our performance was that it would lease up, it’s not really a preleased market there. So our performers always been they would lease up in the year after the show was complete and the show was going to be complete. I think it’s really in the first quarter.

Okay. And then finally the -- pipeline through exchange, do you think it will be more single tenant or a multi tenant?

Well it’s interesting because again I wish I could share with you, but I can’t share with you because we are tied up in non-disclosure agreements but we have multiple major organizations that want either substantial portions like half or so or all of it. And any one of which we would be delighted to have as our tenants and you would be delighted to see us have as our tenant. And we are talking about long long, long term leases.

And some of the common color we are getting from the market is that those kind of tenants don’t like to share -- branding. Can you get that in that building?

I’m not going to comment on that. I’m very comfortable whether we go multi tenant. Look at this way, Jamie the -- we could fill that building up with 100,000 square foot tenants, we could have done it already, but the ones that we are talking to the credit profile is so terrific that it becomes an incredible bond.

All right. Thank you.

You’re welcome.

Thank you. The next question comes from the line of Jed Reagan from Green Street Advisors. Please go ahead.

Hey good morning guys. Do you have a pipeline of new acquisition and developments projects that they actually chasing, do you still feel like there is attractive opportunities out there today or do you feel like you have got enough on your plate at the moment.

Well on the development side, it’s a French little piece of the next to existing development parcels or whatever are always adventurous [ph] to ask. We look at everything. In terms of acquiring existing buildings it’s going to be something that we can fix and create additional value just buying at existing today’s cap rates isn’t particularly exciting to us.

Okay. And just on Southern California couple of quick ones. What are your thoughts on Orange County as a Kilroy market these days, are the areas showing a lot of good job in rent growth and where you get just the one building down there so just curious how you are thinking about that these days?

We look at everything. We haven’t found anything that we like, that we felt was appropriately priced for our metrics would want to be, but we look at everything.

So that’s a market you could see yourself being in longer term?

Possibly.

Okay. And then I guess related to that there has been some press on downtown Santiago catching some momentum and just wondering if you are getting more constructive in that area and maybe do a little more there overtime and then how about thoughts on downtown LA at this point?

Downtown LA we look at, whether we hear a lot of hike but when we go through the numbers its trading tenants. That doesn’t mean there won’t’ be the occasional building that does a trip at -- because it’s unique or whatever but we’re not -- but we look at a lot of stuff. We haven’t seen anything that we would want to act on in term of San Diego, it’s through Downtown in some of the areas has gained some momentum and we’re looking at things but again we are looking at it, we haven’t had anything that we’ve come close to pulling the trigger on and to your earlier question about what are we looking at in terms of acquisitions or whether it’s our appetite for acquisitions are developing. We do have a couple of major development things that we are talking about. And again where we have NDAs with major companies in connection with what be basically buildings that we would build for them that would be buildings, type building and those could be very substantive but nothing reported at this point.

Across a range of markets, or focused on one market?

Let’s call it the Bay area and the Greater Seattle market. And then of course within our development things we are having very good discussions, early discussions on the academy which we should have entitled in the first or second quarter of next year. We have somebody that's interested in all of the office space there which I think Dave, the office breakdown of that project is about 270,000, 280,000 square feet, is that correct.

Yes. That's correct.

So we could we were in the – again its early stage, so its -- but its encouraging because that market has become a market of great demand in the rents and so forth has gone way up and we're just really pleased that we got in that earlier than most.

Can you feel like there's depth there and sort of breadth of that could be to sustain couple of other million plus, 2 million square feet of new development over the next three to five years?

Well, it about 6 million square feet of demand in the Greater Hollywood market involved, it’s something like 20%, 25% of that is growth, meaning, new demand for the market. And with the type of tenants that we're seeing and talking with, they want to have the environment that has vibrancy, the Kilroy is kind of project which is in that market, it’s the restaurants and the outdoor areas and the rooftop desk and all that sort of stuff because that's very appealing to the kinds of consolidations that these are endeavoring to make.

Sure. Make sense.

Yes. I think it's not a huge market, but it’s a great market and the operating cost in that market are vastly lower than Downtown on for square foot basis vastly were.

Okay. Thanks so much. Appreciate it.

You're welcome.

Thank you. The next question comes from the line of John Guinee from Stifel. Please go ahead. John, you may have your line on mute. John, your line is in the call. Okay. And we'll go to the next line, it comes from the line Steve Sakwa from Evercore ISI. Please go ahead.

Thanks. Most of my questions have been asked. But John, I guess I had two.

Hey, Steve, you're chopping out. I don't know whether [Indiscernible] or what, but we can't hear you.

Okay. So, is that better?

Yes. That's great. Thank you.

Okay. I guess it’s too many conference calls, the battery is dying. So on the east side of Seattle we just came back from there and there is definitely couple of new projects that are going up, totals maybe 1.5 million feet and you've also got Expedia that's going to moving to a different campus more in Seattle, how are you just thinking about the Bellevue market longer term?

Well, longer term I think it's great, because this is really an area that has all the amenities and shopping and different price ranges and so forth of for rent housing and condominiums and improving transportation systems and so forth, so longer term very bullish. Well, we saw as this stuff started, we were looking at some of the development sites there and we didn't ultimately pull the trigger, but others have pull the trigger on a couple of them as you know, [Indiscernible] 400,000, 500,000 feet. Salesforce has taken 100,000 fleet there, and there are going to be some buildings coming on stream. The good news for us is that we saw that coming and we did the long term leases that take us through, what is it, let's concur – I mean the key Bay building is solid for many, many years. The other building are Skyline building that we out there where Expedia leases of roughly 100,000 fleet from just. That we think as an opportunity. We have other tenants that are in there that needs expansion. Hopefully we'll able to put something together, but then we have a lot of interest in that building. We have rents in that building that are way below current market and way below what the others are going to need in there to be build building, so if it get to point where there are a period where there is less demand than there is space coming on stream, I think we're in a very good defensive position with the way we have improved that building and what our rental structure is there. It could be that we don't get the growth if that were the case into our rents, but rents are way under market on those leases.

Okay. And then just I guess kind of coming back to I guess another part of Seattle, I guess what your appetite to acquire more land either in South Lake Union or other parts of Seattle at this point?

Well, we look at everything. We're very focused on 333 Dexter. We think we've got a terrific design and terrific flow plans as Rob mentioned we have had quite a few people from the Bay area and elsewhere take a look to their real estate departments looking at what. Let me just go backwards. With most of the companies you could kind of figure out who they are, whether their tenants are down, tenants of ours. We are regularly in discussions with regard to what their requirements are. Where they see their headcount going up and so forth in our market telling them what we are doing, sharing with them what kind of buildings, what kind of space we're going to have coming on stream, at what time, getting input from them with regard to anything they like to see differently. So a very good exchange of ideas with these tenants and that's why we know that there are some that really like what we're doing at 333 Dexter. In terms of the local market there, most everything that's been started to get lease pretty quickly. I like –we made our beat there. I don't see us buying another big site there unless we have tenant at least for the near term. But I'm very bullish on that area. I think it is an area that is very, very similar to the SOMA area here in San Francisco, has the same buy and has all the amenities, all the price points at housing, it just a fabulous area. And the fact is that a lot of people don't want to be in high rise. They want to be in lower rise. Those are two 12 story building.

Okay. Thanks for the color.

You got the new transportation or the big berth of the dig there, that back in operation. So I think we're going to transportationally advantaged with 333 Dexter versus our competition. At fiscal all of the stuff that we look for in a terrific site, so we're focused on it.

Okay. Thanks.

Thank you. And our next question comes from the line of [Indiscernible]. Please go ahead.

Hey, John, it's -- again. I just want to come back to sort of the market overall and totally like your comment, not trying to be Pollyannaish about the situation and then that you relying on the data everything you're seeing on the ground. Everything you're seeing from the tenants, but we know no one rings the bell when it's over. So what are the things that investors should be focused on? What are you focused on to understand that turn when thing start to slow before just picked up in the data, right. So what are things that we need to be mindful of, clearly it’s not the analyst report of the hedge funds, so what are the things that we should be mindful of?

Well, I'm not trying to pick on the analyst, I think there has been since – my sense is that everybody wants to try to be the one that calls the change in the market and we're not seeing that in the data. We're not seeing it in the data with regard to what's been leased. We're not seeing it with regard to concessions. We're not seeing it with regard to demand. And by the way demand is far greater than the 9 million square feet that is the broker show in the third quarter report because I can tell you we're dealing with the bunch that are not – there's a couple of million square feet out there that's not even reflected in those numbers. But there's a whole bunch of things and them as well as I do. You write on markets all the time. If all of a sudden we see massive amounts of sublease space come out. If all of a sudden we see demand really diminish, I mean, those are going to be pretty strong indicators. But what we're seeing is the exact opposite of that. And I think any of you have to come to see us at Nay Reiter [ph] that are on these calls or whatever over the years, know that we have always try to be very conservative with regard to our underwriting and not get our skies. I will admit into Ross's point earlier, we are lot longer in one per sales than I ever wanted to be -- I would be, though we got down there in the bus or that crazy mirror they got fired and we couldn't foreseen that. But I think if all of a sudden we start seeing people saying they don't want to be in San Francisco, they don't want to grow in San Francisco than that is going to suggest that the market is going to become much more regular than the strong growth that we've seen. But I think it was Morgan Stanley they recently came out with the paper, maybe I'm wrong. And it talked about San Francisco and it talked about residential and talked about office and it’s said, half of the growth that we been experiencing, it would be still be an extremely robust market, at least I'm paraphrasing them. I think that we will see at some point the market moderate, but that doesn't mean that the lights are going to turn out. It just been that it’s going to become more normal. The one of the things I'm very encourage by and I was in this market, although Mike Sanford was and Rob Paratte were amongst the other people that work where this up here. It is a lot different that the dot.com area. Nobody was talking about profitability in the dot.com era. They were talking about growth and how much money and value their company was going to work. What we're seeing now is amazing numbers with regard to profitability. But innovation is not going to stop, and all the things I mentioned earlier is that there are more – many of the discussions were having with major tech companies are new initiatives they have, that's why you've got to sign an NDA because they have a new group to do something that nobody ever thought before. So that's why I love this market is because we will see ups and downs, we're not going to see everything go to the moon. We're not going to see every star up survive, we're not going to see every -- instantly become more billions and billions and increasingly more and more billions every six months. But we are going to see an amazing amount of growth from tech sector and you've got embedded here the talent base and the universities. Where these people want to be -- that tech companies what to be, their two first choices are the Bay area and Seattle.

As you think about your comments about doing these larger building leases, long duration, high credit versus filling up building with 100 square foot tenants, which are really probably weaker credit, is that more so in your belief and you mentioned a bond. Do you view yourself as then selling an interest and net assets or selling that asset outright to capture that value in that credit lease, because arguably holding on there, the value question you're going to create immediately but then obviously little growth thereafter how should we think about the strategy that your going about in doing that versus taking arguably little bit shorter duration, smaller leases and filling it up sooner?

It’s a very good leading question and you could figure the answer. But I'm not at liberty to comment on. I'm in midst of our budget negotiation, I'm not going to model them up. But you got a very good sense.

Take care.

Thank you.

And this does ends Q&A; I will now like to turn the call back over to Tyler Rose for closing remarks.

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

Thank you, Tyler. Ladies and gentlemen that concludes you call. You may now disconnect.