Kilroy Realty Corporation (KRC) Q1 2017 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the Kilroy Realty Corporation First Quarter 2017 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Tyler Rose, Executive Vice President and Chief Financial Officer. Please go ahead.

Good morning, everyone. Thank you for joining us. On the call with me today are John Kilroy, Jeff Hawken, David Simon, Heidi Roth, Tracy Murphy, Rob Paratte and Michelle Ngo. At the outset, I need to say that some of the info we will be discussing are forward-looking in nature. Please refer to our supplemental package for 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 8 days, both by phone and over the Internet. Our earnings release and supplemental package 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 first quarter. Jeff will discuss conditions in our key markets and I'll finish up with financial highlights and a review of our updated earnings guidance that was published yesterday in our earnings release. Then we'll be happy to take your questions. John?

Thank you, Tyler. Hello, everyone, and thank you for joining us today. We delivered a strong first quarter at KRC with market fundamentals remaining healthy in all of our West Coast markets. In our stabilized portfolio, we produced excellent results, including a double-digit increase in cash, same-store NOI and exceptional leasing and higher rental rates. In our development program, we expanded the Adobe lease at our 100 Hooper project in San Francisco to include 100% of the office space. We are moving forward with the multi-tenant leasing strategy at the Exchange in mission Bay and seeing significant strong interest from both Life Science and Technology tenants. We stabilized the new office component of our mixed-use Columbia square project in Hollywood, and we are preparing to start 333 Dexter, our first ground-up development project in Seattle later this quarter. On the financing front, we continue to ensure funding for our future development spending with the addition of $560 million of new debt and equity capital. And we remain on track to complete $100 million to $300 million of dispositions this year. Now let me review the quarter's highlights. Leasing was once again a terrific story for us. We signed new or renewing leases on more than 740,000 square feet during the quarter. 643,000 square-feet of this was in our stabilized portfolio as rents were 15% higher on a cash basis and 29% higher on a GAAP basis. The remaining 104,000 square-feet was in our development portfolio at 100 Hooper. At quarter-end, the stabilized portfolio was 94.1% occupied and 95.7% leased. Included in our strong leasing results was 112,000-square foot extension with online travel services provider, Expedia at our Skyline Tower in Bellevue. Cash rents were up 13% and gap rents were up 44% when compared to the prior rent levels. In San Francisco, M&A activity continued to play a role in market leasing activity, App/Dynamics recently acquired by Cisco, expanded its lease in our 303 Second Street building by 67,000 square feet and now leases a total of 150,000 square feet. Cash in gap rents on the expansion space were up 33% and 45%, respectively when compared to prior rent levels. In San Diego county, we signed multiple leases totaling 157,000 square feet of space in several different projects, including our recently completed Heights of Del Mar office property. Additionally, we signed a 50,000-square-foot early renewal with Qualcomm for a 5-year term at one of our Sorrento Mesa projects. And just this week, [indiscernible] signed an agreement to expand its leasing on our Westside Media Center in Los Angeles by 120,000 square feet. The rapidly growing gaming and entertainment company is taking over space from Fandango in Connecticut city when their two leases expire later this quarter. Cash rents were up 37% and gap rents were up 72% when compared to prior rent levels. We have also made progress in our development program, as you know we have three projects under construction, one for sale, 100 Hooper in the exchange. That one for sale in Del Mar, we commenced construction last quarter on Phase 1 which includes building the infrastructure for the entire 23 acre project along with 237 residential units and 96,000 square feet of retail space. We currently expect Phase 1 to be completed in increments beginning in the second quarter of 2018. At 100 Hopper in San Francisco as I mentioned earlier, all 314,000 square feet of office space is now 100% leased to Adobe. We remain on track to deliver the projects in the third quarter of 2018 and expect the 86,000 square feet of PDR space to be leased within 12 months of completion right on our pro forma. And at the exchange on 16th, we are focused on a multi-tenant office, Life Science leasing strategy, you will note that in yesterday's disclosures, we updated our cost, timing and square footage assumptions to incorporate the scope changes related to the building of state-of-the-art Life Science facility. we have strong interest in the project from a variety of tech and life science tenants and remain confident that the exchange will be largely leased by warm shell completion in the second quarter of next year. Moving to our near-term development pipeline, we now plan to commence construction later in the second quarter on 333 Dexter, our approximately 650,000 square foot, $370 million office project in Seattle, South Lake Union neighborhood. Given the strength of the Seattle market, we couldn’t be better positioned to start the project, TL job growth has consistently outpaced the nation, there is a very positive supply-demand imbalance driven by the strong office absorption over the last five years. South Lake Union vacancy is 1.7% and currently has little new supply competing with 333 Dexter’s timeline. And our projects has all the confirmation of another successful KRC development including access to key transportation routes. In addition to 333 Dexter, we have two mixed used projects in our near-term development pipeline, they include our mixed used academic project in Hollywood and Phases 2 & 3 that went in Del Mar. Decisions concerning start dates for the academy and additional Phases going for sale will be made overtime based on the company’s overall leasing progress and market conditions. Let me finish up with a few comments on general market conditions and our expectations for the year. Our experience in the first four months of 2017 is at the West Coast markets where we operate, demand remains healthy, the rental rates for top quality properties continue to rise and that a broad range of industries including Technology, Life Science and Entertainment continues to expand in our markets. We also believe that our focus on high quality well located work environments designed from maximum efficiency and long-term sustainability remains a winning formula that will drive earnings and dividend growth overtime. That said, we’re also aware of the cyclical nature of our business, we continually balance our enthusiasm for growth opportunities with a firm commitment to financial stability and balance sheet strength. We will continue to support both goals with a disciplined approach to development, a rigorous capital recycling program, prudence when it comes to managing our leverage and a clear focus in our decision making process as we continue to drive long-term shareholder value. That completes my remarks, now I’ll turn the call over to Jeff for a closer look at our markets. Jeff?

Thanks, John. Hello, everyone. Let's start with San Francisco. The market posted 1.6 million square feet of leasing activity in the first quarter with six leases greater than 100,000 square feet signed by Uber, Adobe, Google, Accenture, Slack and Cruise Automation. This compares to nine deals greater than 100,000 square feet signed in all of 2016. We view these strong leasing metrics as more relevant to current market conditions than the slightly negative net absorption posted during the quarter. Conditions on the ground remain healthy based on the number of tours and negotiations we are having with tenants, including the leases we have recently signed. Class A direct vacancy was 3.2% in San Francisco SoMa district, 6.3% in the South financial district and 3.9% in Mission Bay. In Silicon Valley, Class A direct vacancy was 6.2%. We are currently 97.4% leased in the Bay area and our in-place rents for the region are approximately 30% below market. As John said, the Seattle office market is very strong, arguably the best market in the country right now, with big tech and new companies continuing to expand their footprints. Since 2015, 6 million square feet of office space has been delivered with 75% that's preleased by the time of completion. The strength of the market is further evidenced by the trend in vacancy rates. Class A direct vacancy in Bellevue stands at 7.4% down from 11.5% last quarter and in South Lake Union it is 1.7% down from 5.5% last quarter. Our Seattle portfolio is currently 97.2% leased and our in-place rents were approximately 9% below market. San Diego remains steady and solid characterized by positive net absorption, continued diversification of tenants and limited supply of large, quality space. In addition to the technology and life science, and we are once again seeing defense grow and add jobs. In Del Mar, Class A direct vacancy was 14% and Sorrento Mesa, 2-storey corporate office vacancy was 5.8%. Our San Diego portfolio is currently 94.2% leased and our San Diego in-place rents were approximately 8% above market. Los Angeles continues to be a healthy segmented market, with growth driven by technology and media centers of the Westside markets, Hollywood, West Hollywood and Beverly Hills. SnapChat's successful IPO should help drive expansion and tech in migration to the market. Further, the LA markets continues to attract a range of capital sources from foreign funds to REITs by offering industry diversification and continued growth from the convergence of technology and entertainment. Class A direct vacancy in West LA was 6.5%. West Hollywood was approximately 10% and then Hollywood is approximately 7.1%. Our Los Angeles portfolio is currently 93.9% leased with in-place rents approximately 13% below market. Across our portfolio, estimated average in-place rents remain 16% below market. Rents on a remaining 2017 expirations are also approximately 16% below market. Finally, as we discussed last quarter, our occupancy declined approximately 200 basis points from yearend 2016, driven by approximately 290,000 square feet of first quarter moveouts. Roughly a quarter of the space is already leased at rents that are 24% higher on a cash basis and 46% higher on a GAAP basis, that's a snapshot of our markets and now Tyler will cover our financial results in more detail. Tyler?

Thanks, Jeff. FFO per share was $0.81 in the first quarter. That includes a noncash charge of $0.04 per share for the original issuance cost of the Series G preferred stock we redeemed during the quarter. It also includes a little less than $0.01 of net leased termination fees and finally it includes a little more than $0.01 of bad debt expense right across a few non-technology tenants in the portfolio. Same-store NOI growth remains strong, driven largely by higher rental rates and tenant reimbursements, cash same-store NOI were up 10% during the quarter, GAAP NOI rose 3%, adjusted for the lease termination fee as I mentioned, cash same-store NOI was up 8% and GAAP same-store NOI was up 2%. Turning to the balance sheet as John mentioned, we completed a number of transactions during the quarter. In January, we completed a 309 million common stock offering at $72.75 per share and the sale of a San Diego building for $12 million, realizing a gain on that transaction of roughly $2 million. In February, we drew down the full $250 million of private placement notes originated last September and in March, we redeemed our 6.875% Series G preferred stock at par for total repayment of approximately $100.8 million in cash. This transaction generated the $0.04 noncash charged FFO that I mentioned earlier. Taking all these transactions into account, we currently have no outstandings on our $600 million unsecured line of credit and approximately $365 million of unrestricted cash on hand. In our debt to annualized EBITDA ratio in the quarter and stands at approximately 5.9 times and 4.7 times net of cash. Now let's discuss our updated guidance for 2017. Before we begin, let me remind you that we're approach near-term performance forecasting with a high degree of caution given all the uncertainties in today's economy. Our current guidance reflects information and market intelligence as we know it today. Any significant shifts in the economy, our markets tend to manage 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 days are subject to several factors that we can't control, including the timing of tenant occupancies. With those caveats, our updated assumptions for 2017 are as follows. As always, we don't forecast any potential acquisitions or acquisition-related expenses. From an accounting perspective, we have adopted a new FASB standard that amends the accounting for the acquisition of operating properties under which we will now capitalize acquisition-related costs, so going forward we won't have acquisition-related expenses hitting the income statement. We anticipate remaining 2017 development spending on our projects under construction to be approximately $200 million to $275 million. We continue to project same-store NOI growth to be between 2.5% to 3.5% for the year. As expected, our first quarter results came in higher than this average from higher rents and free rent burn off from development leases. Growth will moderate as the year progresses given the lower average occupancy from the moveouts we discussed. We are maintaining our projected occupancy assumption for year-end 2017 in the 93.5% to 94% range. As previously noted, the decline from year-end 2016 is driven largely by the group health space in Seattle, already released to Amazon and smaller moveouts elsewhere in the portfolio. This range assumes that the Life Sciences tenant that came into our portfolio as part of an acquisition late last year, remains in the building through end of the year. For our Colombia Square residential tower, we expect occupancy by year-end to be in the low 80% range. Our recurring CapEx budget is approximately $75 million, which resulted in a FAD payout ratio of approximately 70% assuming everything else stays the same. The Board will continue to evaluate the dividend regularly, but we anticipate a larger dividend increase in 2017 as we approach meeting our minimum distribution requirements. In terms of capital recycling, we continue to project 2017 dispositions in a range of $100 million to $300 million, with the $200 million midpoint. Lastly, we continue to plan for the redemption of our $100 million 6.375% Series H preferred stock, callable in mid-August, as with the Series G, redemption, this will be accretive from an economic perspective, but will generate a non-cash charge related to the original issuance cost. This noncash charge is not included in our guidance. Last quarter, we provided an initial earnings guidance for 2017 of $3.40 to $3.60 per share with the midpoint of $3.50 per share. Taking all of our updated expectations into account and considering all of our pre-funding activities, we're effectively maintaining and tightening that guidance level with the $0.04 adjustment for the non-cash charge incurred in March. So we're now providing updated guidance of $3.38 to $3.54 per share for the midpoint of $3.46 per share. This excludes any potential non-cash charges related to future preferred redemption. That's the latest news from KRC. Now we'll be happy to take your questions. Operator?

Thank you. [Operator Instructions]. The first question comes from Craig Mailman from KeyBanc Capital Markets.

Hey guys. On the RIOT Games, could you just give us an expected commencement timing of that and if there is -- how much of the FFO falloff you're expecting from Fandango and the other tenant that are moving out?

Jeff, you want to start that one in terms of the timing when they're expecting to move in?

Well, the Fandango, actually they're going to be moving out in the second -- Q2 and Q3 so it will be 3 months or 4 months after those move outs before they actually take occupancy.

So we really shouldn't expect anything till basically first quarter?

That's probably right.

And how much falloff from the FFO perspective for Fandango and the other tenant?

Well, the RIOT Games lease has a higher rental rate than the Fandango. So once they’ll reoccupied, the rent -- the income will go up. I think we mentioned that.

I'm just looking for the drag until the RIOT Games commences. Is it material or is it not?

Yes, we can follow-up with you after the call on this non-specific income analysis.

Okay. And then just lastly, on the exchange. The extra 50,000 square feet, is that already entitled? Or do you guys have to do anything with the city on that?

Well, no. This is John speaking. We didn't need to do anything with the city on that. We have -- the way they measure and the way we measure, is the way we measure meaning Bulma is different, so we’re just complying with Bulma and the building measured out to be quite a bit bigger, so we're happy about that.

Okay. Great, thanks.

Next question is from Manny Korchman at Citi.

Maybe speaking to the Exchange for a second. John, what's the yield impact of increasing the footage, increasing the cost, delaying the timing and then going to do to the potentially two different tenant types?

Yes, okay, so let me give you this as simply as I can. The cost went from 485 to 560. That's a 15.5% increase in cost. The new cost is 746,000 -- $746 of square feet because the square footage is 750, so we have a 7.2% increase in square footage, a 15.5% increase in cost. The new cost per square foot is roughly $746 a square foot, that's a $54 a square foot increase per square foot, but the rents have gone up substantially since our original underwriting, so we believe we still end up at 8% or better. So we ended up with -- another comment about that is that if you think about the $746 of square foot for the competed product for a brand-new, state-of-the-art life science. Life Science generally is about $100 a square foot more than the office spaces, but we already embedded into the 485,000 quite a bit of the Life Science ready cost, so the added increment, you can see from what I've mentioned. In terms of the cost structure, at 746, you can compare that to recent sales here in San Francisco of Class A, newer product. It's been well north of $1,000 a square foot, $1,100, $1,200 or more. We think we have a pretty great cost structure and well below what other things are trading at. And the last comment I'd make, just for everybody here is that The Exchange has about 700 parking spaces, which is unique. That was a carve-out when they developed the parking guidelines and so forth for Mission Bay. Compare that with, as an example, Park Tower, which is being built here in the North end. It's a high-rise -- rather the east end of the Transbay. It's 750,000 square feet and has almost no parking. The value of that parking or at least the cost that parking at The Exchange is about $30 million, $35 million of the cost and of course that was embedded in the first 485. So I hope that clarifies things.

Thanks for that John and then maybe just more generally, a lot of your 1Q and April leasing was with existing tenants that were expanding. Can you just talk a little bit about new tenants in the market and then how they're thinking about needs in San Francisco?

Do you want to take that, Rob?

Hi Manny, it's Rob Paratte. Q1 was really an active quarter for a lot of technology tenants that are pretty new to the market. What we're seeing is, coming in as not so new is the auto tech, meaning automated driving that sort of thing. Google recently taking one of their subsidiaries out of Tier 70. We're also seeing robotics, artificial intelligence and a lot of smart homes/consumer-related technologies. So it's all about kind of those various areas and then kind of the last, last component of it is health tech, which is sort of the melding of life science and technology.

Hey Manny, this is Tyler. Just on your point about a lot of it was with existing tenant. Actually, of the roughly 900,000 square feet through April, more was new leases, about 500,000 was new leases, and 400,000 was renewal leases. So it's about a 50-50 mix on that.

Thanks for the clarification, guys.

The next question is from Nick Yulico, UBS.

On Dexter, can you just talk a little bit more about the plans to fund the development spending there, now that you're going to start it and also why you decided to I think previously you say you're going to do some more leasing Exchange or other projects before starting Dexter and what changed your mind?

This is John. Let me deal with the latter part of your question and Tyler can talk about the funding. I think we could not ask for a better environment to start a building than what we're seeing in South Lake Union. That 1.7% vacancy -- we deal with a lot of people in the NDAs and so forth, and so we can't get into specifics, but let's just say we think we are uniquely and ideally positioned to have a home run on that project. Tyler, you want to deal with funding?

Yes, I mean as I mentioned in my comments, we have about $200 million to $275 million of expected development spending through the remainder of this year. That includes Dexter and we have $375 million in cash and plenty of debt capacity. So we're well-funded to pursue that project.

Okay. And then on the preferred, I guess, I think you have some more preferred that are callable this year I mean, is there another potential charge coming for those? And then also for another item that maybe could affect guidance at some point is Theranos and what happens to there, whether they -- you got a lease term fee or not, or are there some other situation there? Can you just give us some thought on how those 2 issues could affect the numbers later this year?

I'll deal with Theranos first, okay. Theranos, we're assuming they stay in occupancy and pay rents through the end of the year. We believe that building is leased at well below market. It's an outstanding building and I'm not going to give the answer to what happens if they move out or otherwise because that's inappropriate for us to comment on. But we think we're on a very good position with regards to that market, that asset and there is perspective upside potentially if something should happen to them. Tyler you want to hit the other part?

Yes, and just a follow-up on what other comment, is that we're reserving the trade line portion of their rent, and so we're only booking the cash rent component of that rent, so that protect us a little bit if something were to happen. On the preferred, yes, we have one other preferred, $100 million preferred sitting out there, that's called mid-August. As I also said, the plan is currently to redeem that. That would have a charge of another $0.04 roughly, which is not in our guidance. $0.04 is not in our guidance, but it's likely that we will do that, but we haven't committed to doing that yet so more to come on that.

The next question comes from Joseph Reagan from Green Street Advisers.

So I guess, on Dexter. So would you be -- just to be clear -- would you be starting that on Speck. Then how would you characterize where you stand today in terms of tenant pre-leasing discussions and then is it possible to give an early read of yield expectations for that project?

Yes, this is John. I don't want to get into where we stand on discussions and so forth. It's a highly competitive market and we think we do ourselves an injustice when we put out there publicly, we're backing off and talking about LOIs. We've always tried to be as forthright as possible with regard to when we have LOIs. I'm not sure if it's totally serves us well, so we're going to talk about when we have things leased, but we are very comfortable with where we are in that market and what's the demand that's in that market, which is just extraordinary.

Okay, and so you don't need to have a pre-lease in hand to kind of break ground there?

Well, it's always nice to have one, but I don't think we need one and when we look at what we're doing elsewhere throughout the portfolio with regards to development and with regards to the core, we're very comfortable in adding that to current development.

Got it. And anything you can say about yield expectations at this point?

I don't want to get into that. That influences frequently negotiations and whatnot that we have going on. So I just don't think it's appropriate.

That's fair. And then just on the Exchange. So I want to clarify, is that likely to end up being mostly or entirely Life Science then? Or is that kind of 50-50 lab and office? And then any comments you can give on the sort of the tempo of conversations there or the size of tenants you're speaking with?

Hey Joe, its Tracy. It’s kind of consistent with the discussion I think you and I had last time, but we have here the new budget you saw, the ability to accommodate life science across the project, but the demand remains healthy and consistently split across life science and tech. So the tempo is pretty upbeat. We have a healthy uptick in tour activity as a result of the vertical nature of construction at this point, but we feel good about it in our ability to accommodate, either user group is well positioned within that market based on what we're seeing.

Okay, great. Thank you very much.

The next question is from John Guinee at Stifel.

A couple of quick questions. First, David Simon. Development on the Westside of L.A. doesn't seem to be much of it, at the same time my understanding is there was a push for transit-oriented development. Any update on that? And then John Kilroy, two questions. One, $550 a foot for 333 Dexter seems like a relatively low per square foot development cost. If you could elaborate a little bit on that and what you're actually building there. And then three, asset recycling has been a major component of your strategy the last three or four years, but doesn't seem to be so this year. If you could discuss those three questions.

Yes, David, you want to go first on Westside?

Yes, sure, I'll go first. Hi, John. L.A. in general, Westside, as you know, extremely difficult to build and develop and put new projects up. There is a few going on, as you're aware of, the pen factories, stuff down in Playa. With regard to the transit oriented stuff, related to the Expo line coming up, very important from Santa Monica's perspective and the other cities that it's attached to kind of find the community plan areas where that development can happen. So there is a push by that community and the city to build those kind of projects and those transit-oriented markets, John, with the right balance of products, whether its residential, retail or office. But overall, continues to be difficult in L.A. and the general and specifically difficult on the Westside.

Great. Thank you.

On Hooper or rather on [Multiple Speakers] 333 Dexter, thank you. If you compare that to Hooper, Michelle, what's our cost on 100 Hooper?

6 75

675.

Ann, thank you. John, you know it better than I do. The -- it's about a $100 or so just in the cost of FAR. FAR trades at a much lower number in Seattle than here, but you get lower rents there than here, meaning here means San Francisco. To give a $100 just in that, and then it's a very efficient billing and the cost up there are less, less city extractions and so forth. Here, we have well, they have extractions have there. It's much higher here with regard to contributions towards affordable housing, and all the other things that happens. But in terms of the quality of the project, it is -- it's a platinum, ground-up, higher parking ratio than the other buildings in the area. It's got all the bells and whistles. It's absolutely first class in every way. With regard to asset recycling, if you look over what was the last year, I think we said it was sort of $300 million when we came out with initial guidance than we sort of said it was $300 million to $500 million as I recall. It's higher up between asset recycling and the venture we did close to $900 million. [Multiple Speakers] Yes, 800 and something, so more to come, John. We tried to give kind of another appropriate guidance as we see it early in the year and then sometimes we accelerate it. We'll see what happens this year.

The next question is from Jamie Feldman at Bank of America Merrill Lynch.

I guess, John, just take a step back here, you've been through cycles before as a developer. Can you just talk us through kind of where you're headed in terms of starting new projects. What gives you comfort on Dexter? And just where you think we are in the development cycle given the stocks won't be -- these projects won't be delivering for a good 1.5 years, 2 years?

Yes. I mean, I have been doing this probably longer than anybody. As long as anybody in the industry probably and maybe longer than anybody in the office industry, certainly from a development standpoint, I've been through multiple, multiple cycles. I always start with the premise, you want to have a very conservative balance sheet budget, because you want to be able to weather any storm that comes your way. I as you know, always concerned about the macro environment with regard to things that might go on, but as you drill down into, as an example, 333 Dexter, I just don't think I've seen a better environment to build a building with what the -- what's happened over the last couple of years, what's happened over the last six months, what's happening, I think will happen over the next six month, and I think what will happen over the next couple of years. Think what's happened there. You have some big technology companies and other companies that have been growing tremendously in the city that are headquartered there. You've seen major moves in by Facebook, major new expansions by Facebook. You've seen the same thing happened with Salesforce. You see the same thing happened with Google and if you look at the number of job postings and so forth, Rob, if you can comment on that for a second?

Right now, Jamie there are about 15 to 20 companies that are actively recruiting over 19,000 jobs in the Pacific North, in the Seattle region, specifically, technology jobs. So it's a very robust market in terms of employment and these companies are having to plan their growth over the exact period you talked about.

So I'm very comfortable with the product, with the location. It also happens the big Bertha is a dig that goes under the city, is going to be done concurrent with our building, that's all happening and therefore the streets that intersect Dexter, which will go east and west, they don't go east and west now, will be done. So I think we hit the perfect any with regard to the demand-supply imbalance with regard to the transportation improvements, with regard to the type of product and with regard to visible and expanding demand. So I'd like that. Now that market here in San Francisco, we don't have anything else that we can start. I mean, it's going to be a couple of years before we're able to proceed with The Exchange and we'll have to evaluate that and of course, that's not a decision we have to make today and fortunately we have very good basis there. If we look down at Los Angeles, and we look at the Academy, which we have not pulled the trigger on, we are going to see where we are with regard to the other development that's going on before we pull that and I'm very comfortable with the negotiations were having and the level of interest we with regard to the Exchange. And then down at San Diego, Phase 2, which is of One Paseo, is all apartments, another 300 -- another couple of hundred apartments, they'll probably follow the first phase, and then the final phase there is another couple of hundred apartments and roughly 285,000 square feet worth of office space, and that's a number of years down the road. So I think we -- it feels pretty good what we're doing and I tend to be very conservative, but when there -- when you see the timing is right, this is what we do.

Okay, that's a good answer. If you do -- if you end up leasing The Exchange to more tech and life sciences, is that lower the yields, that 8% you mentioned?

I don't think so, because what we've had is I went through the math earlier with someone, the fact is, we've had a cost increase which averages $54 of square foot and we've had a little time extension because we have to do the warm shell for the life science, which takes considerably longer. But the reality is that the rents we originally underwrote were considerably lower than what we have today in San Francisco. So I still think we end up roughly at 8% ROC up on stabilization.

Okay. And then just finally on both projects, what do you view as the competitive set for people considering [Multiple Speakers]?

For The Exchange?

Yes, and for Dexter.

Well, Tracy, what's the competitive set for the -- that has a similar time line for the Exchange?

Yes, Jamie, I guess I'd answer that, in Mission Bay it really is the only game. I think as you've probably seen this, you've visited us. Mission Bay is totally spoken for or committed to either by way of UCSF and other users that they can see is like sub 3% and the sublease that hit via the motivation Pfizer M&A activity was gobbled up almost immediately. And so there's nothing in Mission Bay and the next competitive option would be whatever comes in South San Francisco, but it's years away, so it remains to be completely tight on the supply side.

Was the same questions applicable to 333, Jamie?

Yes, please.

Well, up in that market right now you have, there's people talk about building a 56-story building in downtown. We don't think that's really the same kind of product as ours, different kind of tenant perhaps. And other than that, you've got Vulcan, which has a 400,000 square foot building that they can build on one of their sites, but they're a better part of the year behind us, if they ever pull the trigger. So I think it's the ideal timing for us vis-à-vis what others can do as well.

The next question comes from John Kim of BMO Capital.

There are some estimates that Amazon is looking to take about 15% to 20% of the Seattle office market over the next few years. And I'm wondering if you agree with that figure. And generally speaking, what you think about a market with such high concentration to one tenant?

We are not going to get into talking about companies with whom we have NDAs with and so forth, we just can't. So what's out there in the general market, you can find, but we can't give you any color beyond that.

It sounds like from your commentary, there are multiple tenants looking to grow in Seattle, so I'm just wondering if you thought, its more diversified than the 15% to 20% figure.

Well, yeah, I mean, like I said, if you look, don't hold me to this exact time frame, but within the last year or two, you've seen Facebook go from 400,000 feet -- they went in with 17,000 feet and then I think they had like 100,000 feet and then it just took 400,000 and some thousand feet, then they've recently announced they're taking another 400,000 square feet on a build-to-suit and another 107,000 square foot or 200,000 another build-to-suit. You've seen Google expand and whatnot. And there's the Vulcan announced that they're doing a big deal, I think its 700,000 or 800,000 feet on a build-to-suite there. You've seen sales force go in, they were a key center in 10,000 or 11,000 feet, we couldn't accommodate them. They thought they needed 100 and they took a lot more. You’ve Amazon jump over to Bellevue as well. You've seen Microsoft renew in Bellevue and so forth. I mean there is a variety of companies that are out there. Obviously, Expedia has been growing, SAP grew in key center and there are varieties of other companies that are growing and have big growth plans. So we're pretty comfortable with the market. And yes, Amazon is the guerrilla in the market. I remember, you know I mean -- I think most of you know, I started my career dealing with aerospace companies and you had five year or 10 year contracts with the government. At the end of the program, if it didn't get renewed, you got to have a big hole in your building. You look at what Amazon is doing. I mean, I think it's probably one of the greatest companies in the world in the diversity of their product and their expansion and so forth. So that's about all I can say, John. I'm not going to get in and breach agreements we have with others.

Okay. On a related topic, there's a recent survey that almost half of the millennials in the Bay Area are planning to leave due to affordability, and I'm wondering when you have discussions with other executives, how concerned are they about affordability for that generation?

Well, you're going to hear a lot of surveys. Remember, they were doing that survey saying that 50% of the people wanted to leave and a bunch of people have left, and then they did the other survey, which showed that more than that number of people moved in. So I thought I'd comment on, there's a lot of whack jobs that write articles and I'm not in that business. All I know is that the case is with the Flower Mart. We have -- we're just now finalizing the selection and we'll be announcing build up I guess within the next month or so, the brokerage team that we put together, which we think is going to be formidable and without even having any formal plan and I mentioned this on prior calls, we've got more than half a dozen major technology companies that are wanting presentations, wanting detailed information, some of which we've met with in connection with their long-term plans, which we think will be the Flower Mart will be a big part of that. So I don't know. I read all the stuff and then when I see what's going on, you look at the expansion that we're seeing within our portfolio, companies like App/Dynamics as an example, Climate Corp. and all these different companies that just keep expanding. It feels good.

Last question for me as I know you talked a little bit about renewals this period and you mentioned Qualcomm, but I was wondering if you can provide some more color on the decision-making process for a company choosing to renew at this time?

I'm sorry, I'm not sure I understood that question.

With supply coming into the market more, you find a lot of tenants that are renewing at this time. I'm just wondering if you can provide some color on that or maybe also if there --?

You mean why they're renewing or I don't understand the question.

The amount of leasing you've done on the renewal side, I just want some color on it.

I think as Tyler said, roughly 850 or whatever it is 1,000 square feet that we've done in the first through the period of the year, tighter roughly, 60% of that was new tenants and 40% was renewals, some of that was, of course, Adobe. People continue to want to have great space, and I think we own a lot of it.

The next question is from David Rodgers of Baird.

Maybe for David Simon, just with regard to what you have left to lease at the Columbia Square on the commercial side of the equation as well as the Sunset and marketing the Academy. Can you talk a little bit about kind of the activity that you're seeing, and any type of stabilization date in your mind for the remainder of the small amount of space you have left?

Sure. Let's start with Columbia Square. As you know, Viacom is in and operating, Fender Guitars in and operating, we're finishing the build outs for Global brands. We have 2 floors left in El Centro, about 32,000 feet and about 10,000 scattered in the Viacom building. Follow that square footage we have -- we're trading paper on all of it, at rents and rates that are pro forma numbers and feel pretty good that over the course of the next quarter or so, we feel like we can button it all up. All entertainment media companies growing, individual companies, organic growth out of Hollywood. So we feel pretty good about that. With respect to West Hollywood and the Sunset, we have the vacancy in the residential -- in the office tower. Again, we had paper trading. We have a tenant or two for all of that vacancy in the office tower. Feel pretty good about that as well. That West Hollywood market is really tight, there is a lot of tenants that up and down that quarter from 9200 Sunset up to our building 8560. Again, media, entertainment focus but feel pretty confident over the course of the next several months, we're going to have that buttoned up as well. And on the Academy, The Academy is such a unique projects, very similar to Columbia Square with respect to what we're doing, creating another environment, another great sense of place, another project that doesn't exist out there. It's going to be very complementary, what's in the market, and we're getting a lot of interest were putting on a lot of pitches. You know in L.A., you don't have a lot of big pre-leasing markets. You don't have a lot of tenants that pre-lease and you think about what we did at Columbia Square and you look at Netflix over down the road, those big tenants came after their projects dot started and what followed within that market was a lot of the tenants of that work with them and a lot of organic growth. So I think Academy will follow a similar path, but we continue to go out and pitch very proactively and we've got a lot of incoming in, both on the retail as well there. So very stable, very good and the activity all through those markets.

John maybe on the Exchange, I know we talked about it quite a bit on the call. Is there something they way the building sets up today that didn't work for the tech tenants? I think you said or Tracy had said that there are tech tenants in demand at that space and you felt comfortable you do some tech deals, that wouldn't be life science, but does that not set up today for them to be able to just kind of move in as you were set for completion here in the next couple of quarters?

I think it works very well the floor plates and the floor heights and the amenities, and all the rest are exactly, I think, 10 out of 10. Vertical construction has been, you now can see it, before it was sort of surrounded by UCSF campus and whatnot and if you were to come out and see it today, it's above the freeway. When did we top out, Tracy?

Like 7th.

And that's on the 12 stories as well?

No. [ph]

We know have something you really can see and understand, so I don't think there's been anything wrong with it. From our standpoint, we have not one to break it up originally other than for big tenants. We don't want to do 25,000 and 50,000-square-foot tenants. It just doesn't come in our view, that is not the way that building should be occupied. So it'll be multi-tenant. It will be a combination of life science and technology, but the smallest tenants, Tracy, would probably what?

It will probably 75, I wouldn't see anything smaller.

75,000, 60,000 feet something like that. So we've been in a situation where we've been unable to take -- to move anybody in immediately because it's not done for another year plus or year about, and that's kind of what's going on. We thought we were going to do a couple of because, as you know, we announced those LOIs and whatnot. That didn't work out for various reasons unrelated to us. But I think we're going to end up with a real home run there.

The next question is from Rob Simone at Evercore ISI.

Kind of a nuance follow-up to Exchange and your rather pending developments. Is it a fair statement to make today that unlike Dexter, that was more market driven as you mentioned that Academy and One Paseo are kind of no longer behind Exchange gatekeeper sort of speak those decisions will be made independently? And then as a follow-up, can you less maybe expand on any -- some of the larger moveouts beyond this year and '18?

Yes. On the first one -- I was -- what an agency to look at is how is the core and is there great momentum there? Are you moving -- renewing, or moving as the case of RIOT Games. We couldn't accommodate Fandango's expansion. And then RIOT Games wants all their space and connects to the space and so forth. That buttons that up. And we look at that kind of across the board not only in each market, but across the platform, how do we feel about the core? How do we feel about what's going on with regard to our developing stuff and fun, what's happening in the individual markets. So use the term gatekeeper, I'm not sure I quite use that, but I think we're going to start 333 Dexter, we're going to kind of take a good hard look before we start other things. You deal with the information you have and the information changes, okay? So there is no way we can know that we're going to be 100% right or 90% right until it's done. We treat this as a very serious business, we're not in the business -- you've seen, we've been very disciplined with regard to acquisitions and whatnot. We're not trying to be bigger just to be big we have no interest in that. We're trying to do the right thing to create the maximum value for our shareholders. So we think it makes sense given the dynamics that I spoke about before on 333. With regard to the Academy, the market is very good, but we're not going to start everything at once. Give you an idea right now, development as a percentage of Tyler of the enterprise is what and when you add 333 what does it become?

That's 11% of enterprise value today and if you have 333 Dexter, it grows to 14%.

And the back end previous times we've been as high as 20% or so. So that's not necessarily an overriding metric, but it's one we look at.

And then just, the other follow-up was, I think if you guys can talk on, if you're able to any of the larger expirations you might have beyond this year maybe in early '18?

So this is Jeff. For 2018, we have a pretty light row, 9.3% of the portfolio. We got four explorations that are 100,000 square feet or more, one in Seattle, one in San Francisco and two in San Diego.

Okay, thanks guys.

The last question is from Tom Catherwood at BTIG.

Yes, thank you. Quick question on acquisitions. I know there's none in the guidance, but if we go back two quarters, John you had mentioned that the acquisition market was looking more appealing and obviously you did a few deals 4Q. How do you view the acquisition market now? And are there any specific markets that look more appealing than others?

Yes. I think what I said, it was appealing in the sense that we found some things that made sense for us. It's hard to find things in scale in the markets we want to be. Those are the kind of quality or whatever where we can get the kind of yields we want. Those are few and far between and if you take a look at the purchases we've done, spent $50 million here, $80 million there, $100 million, $200 million, there haven't been huge projects and I don't see that happening right now. Now having said that, maybe that will uncork something, we'll have an opportunity that I didn't know existed. I don't see acquisitions as being a big, big thing for us in '17. Will things change in '18, I don't know. But we do like the markets we are in and we do like it where we can find something that is, that we can fix. Occasionally, we find something that is stabilized and for one reason or another, it might make sense for us. But you haven't seen us out there buying stuff at 2% and 3% and 4%, unless there was a real opportunity to move it up through value add and I think that's probably going to be the way. Value adds can come in different things. It can come like some of the stuff we bought in the Stanford Research Park. There was a story there that we could buy it and it has some issues with regard to some of the tenants and probably helps us move yields up and you seen us do covered [indiscernible] where there is a big development component downstream in the meantime we get a decent yield that's accretive. Those are the kind of the things that we're more likely to see. We do have a couple of folks that we're dealing with that are either corporations or wealthy individuals that we're talking to with regard to a variety of things, it’s way too early to start announcing that stuff. So we're going to be opportunistic. We're going to make sure our pencil is very sharp and that we're very disciplined.

Got it. Appreciate that. And then Tyler, just a quick one on the bad debt provision this quarter. What drove this? And do you have more tenants on your credit watch list now than you did at say this time last year?

Yes, we've been pretty fortunate over the last many years, where we've really haven't had much bad debt expense at all and this quarter as I mentioned there is a handful of tenants that are generally non-Tech actually that we've taken reserves on, no bankruptcies, but reserves. And we don't think it's a market friend. We don't anticipate that list growing. We don't -- we haven't seen that. More company specific issues that some of them are having including that one I mentioned, which was related to that acquisition. So we don't see it as a sort of market issue at this point.

Got it, appreciate it, thanks guys.

The next question is from Judd Reagan with Green Street Advisers.

Looks like L.A. area job growth been slowing down a little bit and there's been some chatter that West L.A. fundamentals maybe cooling-off a touch, just curious if you're seeing any shifts in demand dynamics and then what type of rent growth you're seeing in the market at this point?

Hey Judd it's David. There are a couple of big moveouts, but with the entertainment, things like that, that's skewed the numbers a little bit. I got to tell you I'm on the ground day in and day out here, both from leasing activity standpoint and acquisition activity and talking in capital that's wanting to come into the market and it's been pretty steady over the last couple of quarters and activity comes on the leasing side in fits and starts and it’s always, been a little bumpy here because the markets are so fragmenting and there are a lot of options. But overall, I don't see anything diminishing on the fundamentals. I think rent growth is in the 3% to 5%, 8% depending which market you're in, but as I've always said when I meet with you, the quality product with the environments and the workplace space that we create and then we own as an example of 5255 in Hollywood, the building continues to have a lot of activity. And it's wants to expand, and that's what you're seeing with our portfolio in the markets that we're in. So I still feel really good about everything we have and the things that we've got on -- in the pipeline.

That's helpful. I think we were probably pushing 10% type rent growth year or two ago. Is that I mean, fair to say you've seen downshift on that some?

You know Judd, I think it depends where. I think it's a little overboard. I mean, it could be as high as 8 to 10 in some of the particular markets depending on the supply-demand dynamic at any one particular time or what tenant needs at that specific time. But I think of your trajectory is in the right direction, and continues to go in the right direction whether it's a couple of basis points higher or lower. I'm not that good, but I think we're moving in the right direction.

Okay. And then just speaking about LA. There were some media reports that pretty big Century City assets is trading [indiscernible] a stake of that is through a private buyer, just curious if that's one that you guys take a look at if you have any color on maybe initial yield on that type of deal?

Century City has not been haven't been focused on for a variety of reasons we talked down the path so we didn't take a hard look at we know what's going on in the market, but we didn't take a hard look at that.

Okay, market cap rate, color, and idea?

I don't.

The next question is from Jamie Feldman of Bank of America Merrill Lynch.

I just wanted to follow up on a 2018 expirations question. Were you saying those were known move that's? Or those are just your largest leases expiring?

Jamie, this is Jeff. Those are the largest leases expiring. The one up in Seattle most likely will not renew. The one in San Francisco, we're in negotiations with a tenant and they'll probably stay in a portion of the building. Down in San Diego, one of the tenants there will not renewed and the other one we're negotiating with. So it's a little bit of a mixed bag between the four.

So it sounds like, so if it's 400,000, it's maybe 200,000 that are saying? That's the right way to think about it?

I don't know if it equates to that. I mean, I guess you can look at it that way. But it's too early to tell, Jamie. We always have some of outs and we've always had some extension. So more to come on it. We're working with all these folks as we always do and more to come.

This concludes our question-and-answer session. I would like to turn the conference back over to Tyler Rose for closing remarks.

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