Kilroy Realty Corporation (KRC) Q2 2016 Earnings Report, Transcript and Summary

Good day ladies and gentlemen and welcome to the Q2 2016 Kilroy Realty Corp Earnings Conference Call. My name is Ashley and I will be your operator for today. At this time, all participants are in listen-only mode and later we will conduct a question-and-answer session. [Operator Instructions] I would now like to turn the call over to your host for today Tyler Rose, Executive Vice President and Chief Financial Officer. Please proceed.

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 web site and will be available for replay for the next eight days both by phone and over the Internet. Our earnings release and supplemental packages have been filed on a Form 8-K with the SEC and both are also available on our web site. John will start the call with a review of the second quarter, Jeff will discuss conditions in our key markets. I'll finish up with financial highlights and review of our updated earnings guidance for 2016, then we'll be happy to take your questions. John.

Thank you, Tyler. Hello everybody and thanks for joining us today. We had very productive second quarter and a strong start to the third quarter. We signed leases in our stabilized portfolio during the quarter boosting occupancy above 95%. We generated another quarter of strong financial results with same-store cash NOI up 12.4%. We increased our dividend 7.1% to an annualized rate of $1.50 per share. We acquired a fully leased office property in Mountain View with excellent incremental development potential. We completed the construction on the residential portion of Columbia Square of mixed used project in Hollywood releasing as ahead of schedule both in terms of rate and timing. In our current near-term development projects we are having meaningful discussions and trading paper for large blocks of space at the exchange in San Francisco at 100 Hooper in San Francisco and a 333 Dexter in Seattle and expect to see significant leasing activity this year. We see final entitlement approvals for our sale of mixed used project in Del Mar and for our 333 Dexter project South lake Union. We sold our three remaining land parcels in Carlsbad and two small buildings in land parcels in Sorrento Mesa. And we are in final documentation on the formation of a joint venture with the large sovereign wealth fund. Let me star there, given that we haven't yet closed and because we are still under our confidentiality agreement, I can't go into too many specifics, but I what I can say is the following. We will raise the platform by $450 million in proceeds, net of some existing debt through the formation of a joint venture in which the sovereign fund will take a significant minority interest in two of our SOMA assets. The closing is anticipated to occur in two tranches with one of the properties closing this quarter and the other property closing in the fourth quarter. We see this as a terrific opportunity to establish a strategic relationship with the world-class organization that shares our interest in long-term value creation as well as raise capital to fund our near-term developments. This transaction is a reflection of strong and enduring interest among sophisticated go to investors in West Coast real estate. Market strength is apparent given our performance and job creation, a significant increase in Bay areas of BC funding back at mid 2015 levels and healthy commercial real estate fundamentals. We saw these same market factors positively impact our second quarter results. In operations, we saw a newer renewing lease on 266,000 square feet of space in our stabilized portfolio at rents that were up 40% on a GAAP basis and 19% on a cash basis. We also have approximately 515,000 square feet of letters of intent approximately half are related to the stabilized portfolio and the other half are related to development projects. In development, we remain on budget and on schedule with our three projects and lease up and one project under construction. First, from Columbia Square mixed use development project in Hollywood, we completed construction on the 160 million 200 units residential tower and moved the project into the lease up during the quarter. Leasing has been very strong. We leased 22% of the units within one month of opening. We project stabilization in the summer of 2017. Second also at Columbia Square, we are leased up on the 370,000 square feet of newly constructed office space where we are 80% committed and expect to be fully committed by year end. Fender Musical Instruments recently took occupancy of its global head force space and Viacom remains on schedule for occupancy late in the fourth quarter. The third project in lease up is The Heights at Del Mar, a 75,000 square foot building located in Carmel Valley, Del Mar area of San Diego immediately adjacent to our One Paseo mixed use project. We have an NOI for approximately one-third of projects. And we have one project currently under construction, The Exchange on 16th, our 700,000 square foot, approximately $500,000 million office campus in the Mission Bay area of San Francisco. As we've shared with the markets, we've been pursuing two leasing tracks for the project, one with the large organization interested in entire campus and the other on multi-tenant strategy. We had thought by the end of June, the first track would have resolved itself, but given macro political issues and vacations schedules for the decision makers, the tenant remains a potential but less likely option. As a result, we have redirected our efforts towards the multi-tenant strategy and are now trading paper with a handful of major tenants within the technology, life science and healthcare industries, each interested in blocks of space in the 100,000 square foot to 300,000 square foot range. As we've communicated before, we won't deliver the project until the end of 2017 and remain confident that we will have it substantially leased well before completion. That brings us to our four near-term development projects where we have made significant progress. Earlier this month, we obtained final approval of entitlements from the City of San Diego for our Del Mar, One Paseo project. The fully approved project now includes a total of 1.1 million square feet including approximately 600 residential units, 265,000 square feet of office and 96,000 square feet of retail space. The total estimated investment is approximately $625 million to $650 million with $425 million to $450 million of incremental spending, which will be phased. Given the strong demand and limited competition for retail and residential components of the project, we plan to start construction in the fourth quarter on the first phase, which will consist of the infrastructure for the entire year of a project as well as approximately 235 apartments and substantially all other retail space. We expect the total spending for this first phase to be approximately $150 million over the next 18 months. Our current plan is to construct the office component once the retail is up and running. At 333 Dexter in South Lake Union, we also just received entitlement approval. We plan to develop approximately 660,000 square feet of office and retail space for a total project investment of $380 million. Detail discussions with respective tenants are expanding as this market continues to outperform. In Hollywood, we continue to make progress on final entitlements for the Academy given our success at Columbia Square and the strength of the Hollywood market that is benefitting from the conversions of technology and media. We continue to target early 2017 for the start of construction subject to market conditions. And finally, 100 Hooper in San Francisco, our $255 million fully entitled 400,000 square foot office and PR project, we've said that we won’t start construction until we make progress at The Exchange or at Hooper itself. We are seeing increased interest in Hooper and could have more news on the preleasing in the very near future. All of our future development plans remain contingent on where we stand on leasing across the company and will be based on strong market fundamentals and tangible demand. Also during the quarter, we made one acquisition completing the purchase of a 114,000 square foot 100% leased office building in the Mountain View Submarket of Silicon Valley for $55 million. The initial return is 6.2%, we view this opportunity as a coverage land play that carries the investment of strong return while we look to create significant value through entitlement and new development overtime. Let me finish with a recap of recent activity in our capital recycling program. During the quarter, we completed the sale of our last three land sites in Carlsbad, the three parcels aggregated about 25 acres and we sold them to two separate buyers for growth proceeds of $14.9 million. In addition, just last week we completed the sale of two small office properties and a land parcel in the submarket of San Diego, the transaction generated a growth proceeds of $49 million. Year-to-date, our capital recycling efforts have now produced just over $330 million of completed transactions, adding in a projected $450 million net proceeds from the joint venture, we are now projecting about $800 million in total for the year or about $300 million above our prior midpoint. In short, we are well positioned to fund new development while maintaining a strong and flexible balance sheet. To wrap up, let me summarize our market position. Our vertically integrated platform with a long history of development success has resulted in certainly one of a highest quality youngest and more sustainable portfolios in the country. Our stabilized portfolio and recently completed developments are generating significant cash flow that has resulted in terrific same-store results and a recent dividend increase. Our disciplined capital allocation decisions have resulted in significant value creation, while maintaining one of the best balance sheets in our sector. We have a team in place that has deep knowledge of our local markets, we’ve recently hired Tracy Murphy who will help the team with life science leasing and future opportunities. We currently operate in three of the top four life science markets in the country and view life science as a natural extension to our platform. We are continuing to set the table to create significant value downstream through the acquisition of two terrific coverage land opportunities, approvals after a long battle that went for sale, entitlement success at our 333 Dexter project that couldn’t really have been scripted better given the strength of our South Lake Union Markets. The positioning of the Academy in the heart of Hollywood that will follow success of Columbia Square, near-term life sciences re-entitlement approval at our 9455 Town Center project in UTCs market of San Diego and longer term through the development of Flower Mart project. We have created a self-funding mechanism for our existing and new development through a successful capital recycling program that will result in the sale during 2016 of approximately 10% of our enterprise value and leave us with one of the youngest and most sustainable portfolios in our sector. The 815 million of new development that we will deliver in 2016 will generate annual EBITDA of approximately $63 million on a stabilized basis, 85% of which is relative to office and 15% which is related to residential. And finally, we operate in the strongest of markets in the country while it really happens I agree with Governor Brown when he recently said that most of what makes America great is happening in California. California is leading the world in globalization and innovation and ranked 7th in the world's economy from a GDP perspective. Four of the world's top-10 largest companies are based in California and no state comes close to California in terms of sustainability initiative. The San Francisco Bay area is the world's leader in technology and second in life science and Hollywood is the entertainment capital of the world. I also want to point out that Seattle has many similarities to California, what I just mentioned. That completes my remarks, I'll turn the call over to Jeff for a closer look at our markets. Jeff.

Thanks John, hello everyone. As John noted market fundamentals remain strong across all of our real estate markets. According to JOL, West Coast job growth outpaced the rest of the nation by almost 65% and our markets command a 17% premium in rents compared to the national average. In the San Francisco Bay Area, market fundamentals continue to trend higher. Net absorptions of the City of San Francisco was positive. 372,000 square feet and rental rents increased 1.5% from the prior quarter bringing the year-to-date increase approximately 6.5%. Class A direct vacancy was 3.2% in San Francisco SOMA district and 5.5% in the South Financial district. In Silicon Valley Class A direct vacancy was 9.1%. We are currently 99.5% leased in the Bay Area and our in place rents for the region are approximately 33% below market. Seattle continues to see strong demand from large tenants expanding their footprints in search of talent. Class A direct vacancy rates in our primary Seattle submarkets of Belleview and South Lake Union were 10.7% and 6.8% respectively. Our Seattle portfolio is currently 98.2% leased and our in place rents are approximately 5% below market. In San Diego, rent growth increased 2.6% quarter-over-quarter and 9.2% year over year. Net absorption was negative in the second quarter driven largely by QUALCOMM's recent move out; however, year-to-date net absorption was 615,000 square feet, 25% higher than last year. In Del Mar Class A direct vacancy was 12.9% and Sorrento Mesa, two story corporate office vacancy was 5.8%. Our San Diego portfolio is currently at 91.5% leased and our San Diego in place rents were approximately 8.5% above market driven by a few large leases. Los Angeles real estate markets continued to benefit from dramatic growth in a wide range of creative industries from film, television, gaming and theme park design, to fashion, food and toys. These industries produced more jobs in Southern California than in any other market in the country. The impact is evident on rents and vacancy rates, especially in the popular submarkets of West LA, Playa Vista, Beverly Hills and Hollywood. Class A direct vacancy rates in West LA was 12.5%. Across our Los Angeles portfolio, we are now at 95.4% leased and our in place rates are approximately 16% below market. Overall, for our stabilized portfolio in place rents were approximately 17% below market. For the remainder of the year, we have approximately 273,000 square feet of expirations. As we look out to 2017, we have just one lease expiration greater than a 100,000 square feet and 40% of the 2017 expirations are in Los Angeles where rents are approximately 25% below market. That's a snapshot of our markets, now Tyler will cover our financial results in more detail. Tyler.

Thanks Jeff. FFO was $0.86 in the second quarter including a penny of acquisition related expenses. Same-store NOI continue to grow in the second quarter up 12.4% on a cash basis and 3.2% on a GAAP basis. This was driven by higher rental rates and the exploration of free rents partially offset by lower average occupancy. Subsequent to end of the quarter, we paid down our credit line completely with the proceeds of Intuit campus sale. These proceeds have been held in with restricted cash account pending a potential 1031 Exchange. Now, that we are not using the sale proceeds for an exchange, we expect to make a special dividend at the end of the year in the $160 million to $200 million. We now have full availability on our $600 million bank line and approximately $80 million of cash in the bank. Based on strong projected 2016 FAD coverage of approximately 65% the Board decided to increase the dividend 7.1% during the quarter, we will continue to evaluate the dividend annually and balance the need for capital to fund development with tax requirements and stronger dividend coverage. Now, let’s discuss our updated guidance for 2016. To begin, 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 current guidance reflects the information of market intelligence as we know it today, any significant shifts in the economy, our markets tenants demand, construction costs and new office supply going forward could have a meaningful impact on our results in ways not currently reflected on 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 updated assumptions for 2016 are as follows; as always, we don't forecast any potential acquisitions or acquisition-related expenses. We anticipate remaining 2016 development spending to be approximately $125 million to $150 million. Last quarter, we increased our 2016 same-store cash NOI growth guidance to a range of 7% to 9% given continued strong results, we are again increasing our guidance and are now in a range of 9% to 11%. We remain comfortable with the year-end occupancy number at the high-end of our previously reported 94.5% to 95% range. In terms of capital recycling, last quarter we projected capital recycling proceeds would be in the $350 million to $650 million with a midpoint of $500 million. As John mentioned, with the recent sales several small San Diego assets combined with anticipated joint venture, we now expect total proceeds for the year to be in $800 million range. While these proceeds effectively positioned us to be able to fund our near-term development through the end of 2017. It will be somewhat dilutive in the short-term. So in terms of earnings guidance, last quarter we provided a 2016 FFO range $3.36 to $3.50 per share for the midpoint of $3.43 per share. We had better than projected second quarter performance of about penny a share, which was offset by a penny a share of acquisition related expenses. The joint venture transaction will be about $0.03 a share dilutive over the remainder of this year. Taking all that into consideration, our updated 2016 FFO per share guidance range is $3.36 to $3.44 with the midpoint of $3.44 per share, which is effectively a penny higher than last quarter's midpoint adjusting for the joint venture and the acquisition related expenses. That’s the latest news from KRC. Now we’ll be happy to take your questions. Operator.

[Operator Instructions] Your first question comes from the line of Jamie Feldman of Bank of America. Please proceed.

Great, thanks. Can you give a little bit more color on the comments of The Exchange in terms of the single tenant versus multiple tenants? And then also does it change your underwriting yield or your projected yield at all, the different types of configurations you might have?

Well let's deal with the last question first. We anticipate beating our underwriting yield, the bigger deal would have been an improvement to our underwriting, a more significant improvement. In terms of color, Rob you are dealing directly with that, so why don't you answer that question.

Yes. Jamie, consistent with Mary and what we told you back then, we are in several negotiations I guess with tenants ranging from 100,000 to 300,000 feet each and they run the gamut from life science to technology and there are quite a few and actually there was a substantial uptick in activity in Q2 2016. So, we are fully engaged with multiple tenants and expect to have some good news here shortly.

Okay. Are they interested in the same spaces or does everyone kind of fall in the place well within the building?

The building is large enough that we can move and fit the pieces of the puzzle together, some of them have growth plans and so that's where it gets a little trickier trying to accommodate the growth of some of these fast growing companies we are talking to.

And then what are your thoughts on - I'm sorry.

Just a little more color on that but we have four buildings in that project that are side-by-side, six storey, a 12 storey, a six storey and a 12 storey and then we can connect them horizontally on three super four. So, what we are going through is the allocation between three of tech tenants and life science tenants that we are working with. And we built the building to accommodate life science tenants when we designed it and engineered it and the foundations and so forth. So we have that capability of going both ways. And we are looking at a pretty tremendous credit profile from both big tech and life science.

And what does that do to the incremental cost?

This cost has projected to the extent that I think we have enough in our budget the combinations that we are talking about and we forecasted a fairly significant amount of contingency. So, I think we are in good shape.

And then just last question from me, just, 100 Hooper it sounds like you are seeing even more demand there, just latest thoughts on timing and how soon we might see a lease there?

Yes. We are negotiating LOIs on a substantial percentage of the project with high credit tenants which if consummated would trigger the commits to the construction later this year. So, the timing I think if things in fall in places we anticipate they are and we are in great detailed negotiations, I would expect that we would have a sufficient amount leased to trigger the construction of that project so that it would start in the fourth quarter.

Okay. And then, sales proceeds to fund development through 2017, does that include the 100 Hooper or that's incremental?

Tyler, do you want to go over the funding?

Yes. That includes certainly assumption that we start all of our near-term developments. So, if we don't start it, we have even more capital.

Okay. Alright, great. Thank you.

Your next question comes from the line of Blaine Heck of Wells Fargo. Please proceed.

Thanks. Just a couple follow-ups on that stuff. So, besides the single tenant user at The Exchange, can you talk about maybe aggregate size of the pipeline times you guys have there and how kind of that compares I think you said it was up from earlier this year, but can you put some numbers around that?

Well yes, I mean we can, I want to be a little careful, but we have NDA so we can talk about specific tenants, but its broken down between tech and life science and within it life science category would also be medical uses and aggregate is somewhere between two and three million square feet, that’s currently foot debt. Jamie had asked the question earlier about in some of that space competing well obviously it is, because we only have 720,000 feet.

Sure, that’s helpful and then just one more quick follow-up on Jamie’s question. So specifically 100 Hooper what is kind of that sufficient amount of pre-leasing that you are talking about, what is kind of the hurdle rate that you would be kind of comfortable going ahead with that especially if they exchange were to kind of remain at 0%.

Yes, I think if we get 50% with what we are seeing, that would trigger it and we might be conservatively better than that.

Okay, and then last one from me John recently there has been some high profile M&A in the tech and TAMI sectors with Microsoft and LinkedIn and now Verizon and Yahoo. I guess generally just how do you see M&A kind of effecting the leasing conditions in your markets especially in San Francisco and maybe LA and then more specifically to LinkedIn you are number one tenant, are there any specific pockets of space that you would expect them to get back?

Well first to the last part of the question, no. Remember that Apple occupies most of the LinkedIn leased space, they occupy two-thirds of it.

Okay.

I don’t see anybody giving back space and if they did the rental rates at which we did the deal are significantly below, very significantly below current market, but they don’t have the right to give back.

Okay. Thanks for the color.

Rob why don’t you just…

Rob you would visit the M&A part of the question.

Sure. Just a little more color, I think the Yahoo, Verizon M&A is interesting and that the core business of Yahoo is really the internet related portion of it. And so I think in that case, there may be a redundancy whereas I think you look at LinkedIn and Microsoft. Microsoft bought LinkedIn for a reason, that was for the talent that LinkedIn has and what we are hearing both from LinkedIn and outside is that there are no plans to shed space, in fact they continue to build out TIs in the spaces they have that weren’t built out.

Your next question comes from the line of Manny Korchman of Citi. Please proceed.

Hey good morning, congratulation everyone. Tyler if we look at the disposition guidance and correct me if I’m wrong. If we look at that on a like-for-like basis versus where you were last quarter, are you actually planning to sell less, but now you are incorporating the JV. Am I thinking about that correctly?

Well we had a range last quarter of 350 to 650 with a 500 midpoint, we hadn’t sold the 500 as of last quarter. We had done the Intuit transaction and one land sale at that point I think. So we’ve now done $340 million or so, so we’ve done more since last quarter of actual sales and then if you just take the 350 and add the 450 you get to the 800.

So, there are no other anticipated dispositions beyond the JV?

Yes. Maybe a very small building that we are working on, but basically no, I think we are saying that we are good where we are this year on disposition.

And then as you have had these discussions about the JV, have you guys or have the capital partners expressed interest in other JVs and where do you stand on that and sort of given that your funding needs are covered, does that sort of wane your interest a little bit.

No, we are not going to get into specifics okay, because we are tied up in knots on confidentiality agreements and this is a one-off transaction involving two properties, but what has been part of our strategic desires and theirs, which matches perfectly is to have a relationship where when you have something you may want to venture. Whether it is existing products or perhaps a larger transaction or a major development project, it's nice to have that opportunity in the quiver so to speak. So that’s strategically the biggest reason why to do this and it’s a well known entity that has a long history of successful transactions with others and so forth so we are very comfortable with our future partner.

Great. That's it from me. Thank you.

Your next question comes from the line of Craig Mailman of KeyBanc Capital Markets.

So AFFO dropped on a go-forward basis, is obviously a lot of these assets have higher CapEx than the rest of your portfolio. Historically, you've been running call it a $0.60 drop between FFO and AFFO. How should we think about that trend into the fourth quarter once these assets are out? How does that narrow on a quarterly basis?

You are right, it's going to narrow [Technical Difficulty].

Yes. I think it would drop by probably about by a third.

So instead of $0.15 a quarter down $0.10 and arguable the sales if you are selling at $1.3 billion and let's call it the high eights and paying down debt and mix of line and other debt [Technical Difficulty].

Conference call that all of a sudden has some other conference on it, operator.

That was Wayne's line, his line is open, that was his line.

Okay, can we turn the line off, if you can ask us a question Craig or are you asking or somebody else?

Can we queue the next one?

Go to the next one please.

Your next question comes from the line of Nick Yulico of UBS, please proceed.

Thanks. I just wanted to go back to when you were talking about earlier the over 500,000 square feet in LOI right now with half in development. Is any of that which is in development relating to the exchange right now?

No comment.

Okay, so it could be various projects, but maybe they exchange too.

We have confidentiality agreements, we want to give people the information we are permitted to give, but we can't give information that we are prevented to give. So I would hope that we would be able to add clarity to that fairly soon.

Okay, I wasn't asking for a name or anything just whether any of that has that you said is in development is actually pertaining to the exchange or not.

It pertains to properties in San Francisco. I'll give you that, not including the Flower Mart.

Okay, fair enough. And then just turning to the mark-to-market on lease commitments this quarter, I think it was 7%. It seemed a little bit low. Was there anything that was driving that a little lower than usual?

I'm sorry. Tyler, did you get this. The first part of the question cut out, I don't know what is happening with our conference call provider, but I’m not impressed. I’m not speaking about your questions just about the fact that I couldn't hear the first part of it.

Yes. Nick, that was the commenced number, if you look at the executed, which is up theoretically at later time those numbers are dabbling through or backup. So I don't think there was anything executed that is indicating a trend if that's what you are getting at.

Okay.

It was 19% on the executed, 7% on the commenced.

Alright, okay. Just lastly, going back to The Exchange and you've been pursuing a couple of options, looking at the big tenant versus multitenants, did the fact that you were looking to possibly do something with the big tenant for the whole building, did that delay any of the leasing of a multitenant building, or was it other factors that maybe tenants you're talking to in a multitenant building have other options they are looking at, buying leases out in existing buildings which is sort of delaying some of the leasing?

I’m not sure about the last part of your question, but obviously we've been juggling a lot of tenants over the course of the last year and there has been a rotation if you will that some of the people that are now in queue versus some that were in the queue year ago. so we've lost a transaction or two in 100,000 to 200,000 foot range of last year, but we have plenty of runway in which to get the project leased. The rental rents have been going up with market, demand has increased and we would love to do the big deals, but with the clowns that have to make the decision now being all on recess. As we've said at NAREIT that if we didn't hear by the end of June, an affirmation of the transaction of the big deal that we would go multitenant and that's what we are doing. Now the big deal can come back before we sign the others, but we are not holding our breath to that simply because the entity that has to decide is one of the dysfunctional entities in the world and you would probably know what I’m talking about.

Thanks John.

As evidenced by some of the people that are now in the political arena, no further comments.

And your next question comes from the line of John Kim of BMO Capital Markets. Please proceed.

Thank you. I was wondering who you thought would win the presidency.

I was hoping for Michael Bloomberg, but he chickened out I guess. You know John, despise politicians in most cases, generally I like some governors and I like mayors, because they actually get something done and they generally are held more accountable. I’m not impressed with the current lineup, but my vote doesn't really count, because I live California.

Okay. Moving to One Paseo, can you just remind us how you plan on positioning the retail and multifamily component of it, and if you are going to do this entirely on balance sheet?

Yes, well we obviously have options, we are doing balance sheet, the first phase of it, we've had all kinds of people come to us that are at retail companies, and apartment companies and so forth wanting to venture, or wanting to buy out one of those spaces or elements. Right now, we think the significant value creation by moving forward with the infrastructure and the first phase is, first phase is a retail. Well it's almost entirely all of the retail a few thousand beat short of the total, but it's just under a 100,000 square feet and it's very well received by the folks that we've been talking with as prospective tenants, as well as the marketplace and obviously had to be wedded by the city and by the community and so forth. So, we know it's going to be very successful. And then the apartment are roughly 620 units or 610 units, as I mentioned we are going to start the first phase which 235 and then roll into the second and third phases as appropriate and office component will be about 275,000 square feet roughly and we'll do that once the retail is done and the sites coined up and so forth again subject to the market. So, at this point, we are contemplating doing it on balance sheet, but we have options, we can venture, we can sell, we can do different things.

And as far as infrastructure, do you have the personnel in place to handle the retail and multifamily components internally?

Yes, yes, we do.

Overall, your vacancy rate is very low but you have a fair amount of leases expiring next year. Where would you like to see that figure heading into 2017 and can you provide a mark-to-market on the 2017 leases?

Tyler.

Yes. This is Jeff. For the 2017, we've got about 9.3% of the portfolio rolling, which is very measurable, mark-to-market we are basically 17% under market for next year as well.

Okay. And then finally, John, you mentioned a few times in your prepared remarks how young your portfolio is. Is there a specific range or target that you have?

Well, no, we consider property, I mean 250 Brannan Street is 110 years old, but we consider it new, because it was totally redone. But what we think is really important and we think the investment community should really take a look at this is that we have a very young portfolio, it's been very modernized, much of it is brand new, it comports to the way people use base to the densities that people use in space, the mechanical needs they have et cetera. And we've been the leader two years running in North America across all the different real estate types in sustainability and increasingly, people are focused on that kind of space and so we think it has a lot less CapEx and we think it has a higher demand and we think we'll achieve higher rents than in a lot of the existing stock, which by the way, for example, if you look at the vacancy rates here, our sub lease space rather in San Francisco which is roughly 2 million square feet. Half of that's north of market and fairly obsolete space. So, we know that kind of product we have is and will continue in our view to be more successful than older buildings which have more CapEx and don't have the capacity to handle the higher density. So, I think our average age is 10-years in our portfolio. I would put that against anybody else in the country.

Thank you.

Your next question comes from the line of Steve Sakwa of Evercore ISI. Please proceed.

Thanks. Good afternoon or good morning out there. I guess John, first question maybe for you or for Jeff. Just in kind of your broad discussions with tenants, I'm just trying to understand kind of their psychology around kind of space needs and how that might have changed just given kind of what is going on in the world and in the economy. Are they kind of more optimistic, less optimistic? Just kind of what is the general tenor of the tenants today?

Well we are seeing significant numbers of expansions throughout most of our markets and a lot of that is not only now but two and three years out. If you look at Seattle, maybe we just rolled through the different markets real quickly and kind of what we are seeing, but just a big picture, I would say the markets are filled much stronger today than they did at any point earlier in the year.

Definitely. Steven, Seattle and most of this is public, you look at whose looking in the market, now there is Apple, there is Amazon, there is Facebook, Uber, Google Sales Force, all of them are looking for space they have taken initial premises, they are looking for more and I mean I would say every two weeks there is a new name on the list. And I think another part of your question is what we are also seeing in terms of sentiment from the tenant side is they are making the capital commitment in their premises to deliver space that helps them retain, hire and keep the best and brightest employees. So there we see them spending money on tenant improvements and all sorts of employee benefits that hasn’t scaled back. In fact I would say it’s probably ramped up.

And when you talk about Seattle, I mean you could go through the - I’ll talk about a couple of cities, San Francisco, same thing big tenants in the market, AIR, B&B, again Facebook in the paper yesterday Pintrest, Amazon, Apple again. Mike do you want to touch one Peninsula?

Sure, very similar things on the valley Steve, I think 13 straight quarter of positive absorption of the valley, Google just took another 600,000 feet Sunnyvale, LeEco bought Yahoo land, which they plan to build 2.5 million to 3 million square feet, QUALCOMM it will lease in San Jose for 350,000 feet. So I would say across the board very similar and then maybe David do you want to take LA?

Yes, so similar echo on the comments, media and entertainment continue to grow, you look at Playa Vista where Google is going to take the balance of 600,000 feet at Tishman's building and that would suck up the entire square footage in Playa. You roll through Santa Monica where rates continue to move up for the smaller guys. Westside, you have a 12.5 kind of on the paper vacancy, probably half of that space is probably not functional, and functionally obsolete, it will never be filled. We are seeing the entertainment and media companies modem use like HBO, ShowTime, all consolidating however we are seeing a lot of activity on the organic growth of smaller guys that are expanding, we don’t have stitch of space left in 6255 and we’ve got a lot of activity on the balance of Columbia from tenants to 15 to 25 and feel confident by the end of the year we will be buttoned up there. So I think the sentiments up and down the coast are similar.

And in San Diego kind of finishing the thoughts Steve, we have Intel down there looking for large amount of space, Northrop Grumman, CareFusion, so as everyone has said there is a lot of activity and I think the one thing we didn't touch on is life science in each of these markets. And that's why having Tracy Murphy on Board is going to be you know a real uptick for us in terms of you know the demand that's coming from these knowledge communities like Mission Bay as a result of Big Pharma in collaboration with public institutions like UCSF is just going to continue to grow. You are seeing it in Cambridge, you are seeing it here on the West Coast, so I think you know the trend we see is continuing.

Okay, that's helpful. John, I guess, as it relates to the exchange, I'm certainly not asking for names of tenants, but when you just sort of look at who you are talking to today, are those tenants that are already currently in sort of the downtown or Mission Bay area, or would you say those are tenants relocating with a first-time presence in the downtown area?

Combination, combination of both.

And I guess presumably it's expansion space for all of them, or as opposed kind of musical chairs and relocating from other areas?

Yes, again I got to be careful because confidentiality agreements, but there are number of people that have space here that need to grow beyond their existing premises, so it's expansion, we are seeing that at both the projects we mentioned are 100 construction exchange and the other 100 Hooper and we are also seeing some folks that haven't traditionally been in San Francisco that are technology companies that are big, big tech that want to be here. And so we think we are in a cap hertz position in some respects, because if you think about it Kilroy between the exchange 720,000 feet and 100 Hooper 400,000 feet controls the lion's share of available low midrise space that is generally the most sought after by those kinds of companies. So based upon the negotiations that we have going on right now we think we are going to do very well on both those projects and similarly with 333 Dexter up in Seattle, because it's exactly the same phenomenon.

Okay. I guess that was my last question which you kind of touched on. But 333 Dexter is a large project. Do you envision that going to one tenant, or do you envision that being a multitenant? And what level of preleasing would you want to see in order to kick that off if it's not a single user?

Yes well, I don't want to get into too much detail, because all the tenants listen to everything, but we've got a couple of big users that are interested in substantially all of the property right now. We could do multitenant all day long. Seattle is not traditionally been a preleased market, but we think we are going to be successful in preleasing based upon deals that we are discussing right now and the fact that the market is just absolutely breathtaking in terms of what is happening. There is a certain tenant right now that looks like they are taking the 600,000 feet or thereabouts that's in the Denny regrade location. We have some vacant space or subspace rather that's not going to be renewed in one of our buildings in South Lake Union is roughly a 120,000 feet, we have multiple different people that are bidding on that space. So the demand profile in that city is really good and I hope to be able to see us do some substantial preleasing. Would we start expect potentially but what would we have to do to start expect, we want to make sure that we are well leased at the exchange and so we are not going to get over our skis I think we made that clear to everybody before and we are very encouraged by what we are seeing across our markets right now with current demand and so much of it is really big tech. And by big tech I’m talking established companies with massive balance sheet with real growth plan.

Okay guys. That's it for me. Thanks

Thank you.

Your next question comes from the line of Vincent Chao of Deutsche. Please go ahead.

Good morning/good afternoon everyone. Just going back to the 100 Hooper here, I think I heard, when you were talking about the exchange, about two or 2 million or 3 million square feet of activity around that project. I was just curious if you had the numbers for how much demand is behind 100 Hooper. And then also I think that one, the focus had been on The Exchange and not as much on marketing 100 Hooper. So just curious. Was there anything specific that changed to spur some additional interest at that site?

Well, we've bought the site about a year ago and we said we are going to hire brokerage team and we kind of revive the plant a little bit, which we did in both case and began to market it. And we've always made clear that we wouldn't start Hooper unless we had either substantial progress at the exchange or substantial preleasing at 100 Hooper and it would be wrong for anybody to think about the exchange of 100 Hooper are somewhat fungible between tenants. They are two different markets. Some tenants would go in either location. Some tenants will only go to Mission Bay and the exchange. Some tenants will only go, to stay in that market that 100 Hooper. So again there maybe occasion that are attractive to the same user, but we think there are more as unique submarkets within the city. And what has happened is that we have as result of our marketing efforts at 100 Hooper and covered a number of folks that want to be there and so we are negotiating detail paper, couple of write-down. And you ask how much and let's just say that we've got more than enough to fill up the building, if they all go together.

Okay thanks for that. And just curious, so AVB, we heard from them this morning, and they were talking pretty cautiously about San Francisco. Obviously, there are different property types, different parts of the cycle. There is some supply coming on there. But they did specifically mention job growth and some demand softening there, but it seems to be in contrast with the increased activity that you guys are seeing in San Francisco. I was just curious if you had some thoughts on what your outlook for job growth is overall for that market, and if it's just that the slowdown is coming from parts of the market that you are not really catering to for these two projects.

Well, I again I don't what we have statistics or Mike with regards to what the protection is for job growth for the market. I can you tell that don’t confuse office and apartments. We want everybody to do well, but a back off in rent increases in apartment is actually a very good thing for the office community because it makes it is more affordable for the people that they are unable. And again, what they're talking about current rents that are more cautious about et cetera. We are talking about deals that we are working on for occupancy that are year and half are sold out, d we have benefit and numbers of job growth, we'll have to get that to you, I don't think we have that in our file [indiscernible].

Okay. Yes, I think the caution was more of the job growth side of things, which obviously has an impact on rent. But it does seem like you are seeing some good demand there, so just trying to understand the differences. Okay, thanks.

Your next question is from the line of John Guinee from Stifel. Please proceed.

Okay, great. Actually just a couple of questions off case a bit. Hey, Jeff, I'm looking at Southern California, and while I get that San Francisco Bay, your leases are 33% below market, I get that San Diego 8.5% above market. There aren't many sub-markets in LA that are below 10% vacancy. Yet I think you are thinking that you're 16% below market in your LA portfolio. Any more detail on why you are so far below market in those markets?

I’m not sure so, John I mean so, for LA obviously mark-to-market we are at 16% for all of our properties in LA.

But El Segundo and Long Beach are not particularly great markets. Do you just have low in-place rents there, or what is driving that below market number?

I think mainly West LA, West LA as we've got huge upside mark-to-market in our West LA portfolio in Santa Monica, that's really driving more than anything.

Got you. [Multiple Speakers] John, I'm just looking at all your development portfolio, and the investment basis looks pretty good in most of them. Let me just ask you a couple of questions. $700 a foot on Exchange Place looks like a pretty good number, $640 a foot at 100 Hooper, $580 a foot at 333 Dexter, $600 a foot at Paseo, $700 a foot at Academy. Anything we are missing on those investment basis development basis per square foot? And then a question I guess for David Simon. It looks like the Columbia Square project that you just delivered came in at almost $800 a square foot. Any idea why that's so high?

Well have, you remember we had overall number John and you have the residential component based into that. If you break it out the office series in the 600 square foot range and the resi on per-unit basis is as we said a 160 million and then we had the historical. So, when you look at the components, they are all where they should be relative to returns and the markets that they are in.

Okay. And then any investment basis John that we should be concerned with on your development pipeline?

I don't think so, for a long term we were sort of squaring at down at 1% because we didn't have entitlement and so forth but now we do. There are a few reputable are fully entitled and the yields there won't be as high as - they won't be in the 8% range but remember about - what it 60% of the project entitled Michelle is resi?

Correct.

So, we are going to be overall there, we think we've been pretty conservative in our underwriting and in our contingencies and our forecast for potential increase in cost and we are still with the 60% of it resi. What is it, 15%, 20%?

25% office and 15% retail.

We think we are going to be there producing in the sort of lowish mid six yields overall may be a little bit better.

Okay. Thank you.

You are welcome.

Your next question comes from the line of Michael Carroll, RBC Capital Markets. Please proceed.

Thanks. Tyler, you mentioned the possibility of a 1031 exchange later throughout this year. I guess can you guys give us some color on the type of acquisitions the Company is pursuing and the likelihood of closing some type of transaction?

No, it's the reverts. We have sold an asset at the beginning of the year and have put the money into an account, but in the case of doing it 1031 we decided we are not going to do a 1031. So the money now we pulled out of that account and paid down our lines. So we have now plans to do a 1031 at this point.

Okay. And then can you talk about how long it would take to deliver 100 Hooper Street once that project breaks.

It's about 18 months Mike?

16 months to 18 months yes.

Okay. Great. Thank you.

Your next question comes from the line of Jed Reagan of Green Street Advisors. Please proceed.

Hey good morning, guys. I think Mike touched on this, but there was a media report yesterday that Facebook is looking at a big office lease in San Francisco and specifically Central SOMA. Can you comment about any conversations you may have had with Facebook about your projects there, especially Flower Mart? And then can you just remind us what the latest timing is for the city to make some decisions on the Central SOMA redistricting plan?

Well, I'll let Mike deal with the latter part, the first part we are not going to talk about any discussions we are having with Facebook or anybody else specifically until if any particular tenant that we are talking with or may be talking with until we have deal, because we are just not going to do that. With regard to the Central SOMA. Mike.

Yes, I think that still remain on-track we are looking for a certified EAR later this year and then sort of administrative approvals thereafter early 2017 plus or minus.

Okay, great. And can you talk a little bit about how the investor demand for your San Francisco JV offering has fared I mean were there a number of parties you were talking to there? And then just how is pricing there shaping up versus your initial expectations?

There are number of people that wanted to do transactions with us on various assets in San Francisco and elsewhere. We went through a process over a course of I don’t know of six to nine months talking with various sovereigns and other major players to determine who we thought would line up with their strategic interest and our strategic interest being most in alignment. And pricing was heavily negotiated and it will be I think consistent with where other things are trading in the city today.

Okay. Thanks. And on the Sorrento Mesa sale, can you talk about how the buyer allocated pricing between the land and the buildings? Am I correct in thinking that those two buildings had a fair amount of vacancy in them?

The two buildings were both basically vacant, but we can't comment on their allocation. I’m not even sure we know what their allocation was.

Okay. That's helpful. And last one for me, how much up selling potential exists at the Mountain View acquisition, and just kind of what is the process and timing for getting at those FARs?

Yes, I think just in general not amuse the market, obviously that we would love to be and expand more, it’s tough to get into, I think we found this opportunity that is definitely under-densified currently. I would say many parts of Mountain View overtime have gone through up zoning and it's very common to see up to a 10 FAR plus or minus. This area in particular would still need to go through a process and as John said we’ll be working through that over time, but it wouldn't be unreasonable to think about our 10 FAR plus or minus in that area.

Okay, you know should we think about that more as the next cycle type of play.

Yes, we are not counting on it this cycle, we've got four years left with the tenants. You recall we bought an asset I think it's called Chesapeake something at Sunnyvale right on the freeway a year or two ago, which was a similar kind of transaction, roughly the same yield but with a big upside on redevelopment. So we think these are pretty good ways to get us you know decent we call them covered land transactions where you get a decent yield going in slightly accretive and you have big upside that can generate substantial increases in value over time allows us to focus on those and get have them ready for the next cycle. I can’t and I'm not going to call when this cycle ends and the next one begins, I mean it assumes it still be going just fine.

Okay, great thanks.

Your next question comes from the line of Dave Rogers of Baird, please proceed.

Hey John, earlier I think Steve asked a question about preleasing uncertain development, but maybe take that a different way. Do you guys look at it from a risk perspective in terms of total capital at risk on a speculative basis that you would be comfortable with? I guess if you threw Exchange in there and then kind of the four new developments plus the resi that's kind of leasing up now. Do you kind of have a max limit in terms of total dollars that you want exposed on a speculative basis at any point? Maybe a different way to think about preleasing?

Yes, you know we get asked that question from time-to-time, but we don't really put ourselves at the hard and fast, because where I have kind of made some mistakes in my career and I speak here to me, is that it can be a modest about, but if you are doing it at the wrong time then it can create you know a lot of pain. We look at it more about not - I guess we could look at it as a percentage we really have and we've looked at it more what is in the market, what demands in the market, we are so involved with companies with regard to our long range planning that we have a pretty good feel for what is out there. We want to see big visible demand, we don't want to have huge volumes of dollars invested in projects that are vacant. I know everybody is wanting to see progress on the exchange that we are dedicated to make sure we show progress this year, but we look at it both industry risk, geographic risk, dollar risk, timing risk, we look at our existing portfolio and we look at what is potentially coming due, because we obviously don't want a huge amount of spec space in a market, where we have a huge amount of space coming due in the same year or same period. so we take all those factors into consideration, and I think what we are going to see in the remainder of this year, I think we are going to see some pretty good leasing activity based upon deals that we are working on right now across the portfolio. So I’m hopeful that we are going to see substantial lease up in The Exchange and substantial pre-commitment at 100 Hooper in order to start it and at 333 Dexter we talked about that. In One Paseo, we are not going to see substantial pre leasing in the first phase, because most of that's resi and then on the leasing of the retail, it's not big box stuff, so, it's probably maybe 40%, maybe 50% that we might do pre leasing there. So, that's kind of the big view.

David at Columbia Square the remaining 20%, sounds like it will be leased by the end of the year, occupancy close to year-end or will that trail into 2017 or 2018?

It will probably trail into early 2017 and we should be buttoned up by the end of the year with the amount of activity we have and the paper we are trading on the balance of this phase. So, yes, that's a good assumption.

Alright great. Thanks. Tyler, last one for you. In terms of doing a joint venture sale but doing a minority sale, I assume that's having no impact on the need for a special, that that's coming from the traditional asset sale this year, or is there some impact there?

We are working on structuring tax differed transaction, but it hasn't been completed yet, but that's the plan.

Okay, great. Thanks guys.

Your next question is from the line of Jamie Feldman of Bank of America. Please proceed.

Just a quick follow-up for Tyler, can you just update us on your thoughts on CapEx and AFFO or FAD for the year?

Yes. I think we are projecting 65% payout ratio on FAD for 2016, about the around a little bit here and there with CapEx, we have a overall CapEx TI leasing commission buildings maintenance budget of around $80 million will probably come in underneath that. But it's trending similarly to the prior year.

Okay and I think that’s the reason on the last call too.

Yes.

Alright, great. Thank you.

There are no questions at this time. I will now hand the call back to Tyler Rose for closing remarks.

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

Ladies and gentlemen thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a great day.