Q1 2022 Kilroy Realty Corp Earnings Call
This call is being telecast live on our website and will be available for replay for the next eight days, both by phone and over the Internet our earnings release and supplemental package have been filed on form 8-K, with the SEC and both are available on our website.
John will start the call with first quarter highlights and Elliott will discuss our financial results and provide you with updated 2022 earnings guidance, then we'll be happy to take your questions John .
Thank you Bill Hello, everybody. Thank you for joining us today.
I'll begin with some big picture comments, and then share highlights from the quarter.
We recently passed the two year Mark from the start of the pandemic and are starting to see what a new normal looks like.
People go back the city's kids are attending school in person and travel is return on that last point. It was great to see so many of you live at the Citigroup Conference in March Physic.
Physical office occupancy has continued to progress many of our largest customers started returning to the office in recent weeks the effects of which are tangible and our markets traffic is up public transportation is more crowded cities are cleaning up and starting to feel more vibrant.
Ridership on Bard and the Bay area was up roughly 20% versus last month and over 140% versus last year.
We are encouraged by the initiatives San Francisco took last month with their well come back to SF plan encouraging employers to return to the office.
Who sign the pledge, including many companies such as Google, Microsoft better sales force Uber and Kilroy committed to implement in person work policies beginning in March.
So while we expect the coming months to have some fits and starts we are feeling more encouraged by the progress to date.
One thing that has not changed throughout the pandemic is the importance of technology and life science companies as an engine that drives our economy.
Since the start of the pandemic over two years ago. The NASDAQ is up roughly 90% VC funding is up 85%. So while there will be volatility year to year access to capital for these industries remains robust.
Hiring continues to be very healthy as well job postings for large technology companies in our markets is up roughly 75% year over year, highlighting the growth in competition for talent on the west coast and in Austin.
Despite all the headlines companies continue to lease office space. According to J O L. Leasing nationwide has increased for five straight quarters and the first quarter of 2022 have leasing volume that represented approximately 75%.
Pre pandemic levels technology, and life science customers remain a major driver of demand, especially in our markets. A few examples include meadows signed at nearly 600000 square foot lease in downtown Austin, and a 200000 square foot lease in Bellevue, Bristol Myers Squibb took over 400000 square feet.
In the UTC Submarket in San Diego, and Rob <unk> Gaming company leased 200000 square feet in the Bay area just to name a few not surprisingly a disproportionate amount of this leasing has been a newer and more a minute type buildings.
Our strategy has long been to buy and build the best office and life science buildings in our markets in order to attract big sophisticated and growing users are Green Street report from last month annualized portfolio quality among the publicly traded office companies.
Hey, Kilroy scored over 90 out of a possible 100 points ranking us number one in a group of peers, our commitment to modern a minute ties and sustainable workplace environments differentiates our portfolio.
And positions us to succeed in multiple environments.
On this note we would like to point out that earlier. This month, we followed our 11th annual sustainability report.
Sustainability health and wellness are integral to both us and our partners. Our efforts continue to earn global recognition from leading organizations, including G. Resp, Dow Jones, NAREIT and energy Star. These initiatives remains central to core values and we plan to continue to being a leader.
In these areas.
But we are not without challenges geopolitical risk is elevated inflation is accelerating and the capital markets remain somewhat volatile. While these macro factors are beyond our control are long term leases high concentration of creditworthy tenants and low leverage provide a buffer to navigate any short term chop.
In us.
In summary, our portfolio quality is strong tenant credit and fortress balance sheet position us for both defense and offense, our downside will be protected in tough times is seen by the resilience of our portfolio during the pandemic we have.
Paired to be opportunistic when appropriate as we demonstrated through active capital recycling this past year.
Turning to the highlights from the first quarter leasing was headlined by the renewal and expansion of neuro for 114000 square feet in mountain view through 2032, we're pleased to be able to grow with this innovative company, which represents another VC backed company expanding in the Bay area.
After a slow start due to the omicron variant activity improved throughout the quarter and we are currently in late stage negotiations on more than 350000 square feet of office and our core portfolio across multiple markets. While there are no guarantees these leases get done it demonstrates the improved tenure.
Confidence in the market.
Overall leasing spreads on deals signed during the quarter were plus 7%, it's worth noting that our leasing spreads stayed positive every quarter throughout the pandemic a testament to the quality of our real estate and the built in growth within our portfolio.
And our lease rollover remains modest with an average of 7% expiring per year through 2025.
We continue to see strong residential demand in our markets, which is good for our multifamily portfolio in the near term and encouraging for our office portfolio in the longer term.
Roughly 1000 residential units are 97% leased as of today <unk>. Our most recent project in Hollywood Dow sits at 94% leased a mere 11 months since delivery and is achieving top of the market rents at nearly $6 per square foot.
Life Science continues to be a point of strength across all markets with vacancy rates in the low single digits leasing activity for life science projects remains robust and we continue to have good interest in both Kilroy Oyster point and our future started in San Diego, Santa Fe Summit as jewelry as a reminder, upon.
<unk> of all phases of these developments NOI from life science properties could get as high as 30% of total <unk>.
<unk>.
On the capital allocation front, we began construction on the last two San Diego Life Science Redevelopments.
Pardon me, we discussed last quarter.
Total we now have three life science, Redevelopments, which have an estimated total cost of $115 million, a roughly $60 million of incremental spend all three projects are fully leased and upon stabilization will generate $20 million and total NOI or $10 million above pre redevelopment levels.
Additionally, during the quarter, we continued our expansion in Austin by acquiring a land site in stadium district for $40 million. The Stadium district together with the adjacent domain Submarket have become Austin second downtown with 4000 apartments, 50, restaurants, 900 hotel rooms in close proximity.
Class a office market is roughly 3 million square feet are 99% leased to several customers, including Amazon meta and indeed.
Our site is Kitty corner to the southern end of the domain close to a future light rail stop which connects the downtown and most importantly is directly adjacent to the brand New Q2 Stadium home to Austin FC Austin's Major League Soccer club and the only professional sports team in the region.
As part of the land acquisition, we have a permit ready high quality design from one of our favorite architects, which allows us to lock in G&P G&P contracts, which we've done with the builder we expect to start construction later this year in total we expect to spend just over $700 per square foot, including.
The entitled Land, which as I mentioned, we previously closed on to develop what we believe will be the best building in the Submarket that will complement R&D tower, the best building in the Austin CBD.
We also make progress building out our team in the region. We recently announced the addition of Fernando <unk> Senior VP of leasing for Austin based team Fernando a graduate of UT has been in the Texas commercial real estate for over a decade and brings to kilroy Austin market relationships leasing.
Acumen and transaction expertise. We also have two very seasoned executives who will be.
Relocating from the West coast to oversee asset manage but in construction in the Austin market.
To recap since June of 2021, we have acquired two projects in Austin that will total $1 2 million square feet or roughly 5% of total company NOI and put together the foundation of our local team that will facilitate our continued expansion in the region.
In closing last quarter I outlined five objectives for the year complete and lease our development projects proactively manage the operating portfolio look for external growth opportunities maintain a conservative balance sheet, and lastly engaged politically when necessary to help shape public policy.
While it is still early in the year. We are pleased with the progress on several of these initiatives and we remain committed to these goals as the year progresses that completes my remarks, now I'll turn the call over to Elliot.
Thank you John .
<unk> was $1 16 per share in the first quarter. This includes <unk> a positive onetime items from lease termination fees and moving some retail tenants back onto accrual accounting offset by <unk>, a frontloaded G&A spend taking the net of the two adjusted <unk> for the first quarter was $1 14 per <unk>.
There are <unk> higher than last quarter, largely driven by a full quarter of revenue from Kilroy Oyster point phase one.
On a same store basis first quarter cash NOI was up 12, 8%, excluding one time items and adjusting for tenants that were not paying rent in the first quarter of last year cash same store NOI was 10, 1% for the quarter. This growth was driven by lease up at the residential portion of <unk> and <unk>.
Rent burn off for some larger office leases GAAP same store NOI was up nine 1%.
At the end of the quarter, our stabilized portfolio was 91% occupied and 93% leased.
The decrease in occupancy from the fourth quarter was driven by 145000 square foot move out in San Diego that we previously discussed.
Turning to the balance sheet, our liquidity today stands at approximately $1 3 billion, including approximately $175 million in cash and full availability of our $1 $1 billion revolver.
As we have previously discussed our line of credit combined with cash on hand, and our projected dispositions will more than fund the development pipeline through 2022.
Net debt to Q1 annualized EBITDA was five nine times and we have no debt maturities until December of 2024, as a reminder, last year, we issued $450 million of bonds to six 5% and used the proceeds to redeem our 2023 maturity, thereby giving us plenty of runway to navigate the current debt markets.
Before we get the guidance one change we made to our disclosure. This quarter is on page 18 of the supplemental where we expanded the pool the pool of deals for change for the change in rent calculation.
This number was based on spaces that had been vacant 12 months or less given.
Given the decrease in activity during the pandemic, we are starting to see leasing in more spaces that have been vacant for longer than 12 months. So beginning this quarter. Our change in rent calculation includes spaces that have been vacant since the start of the pandemic, which should give investors a better sense for what is going on in the portfolio.
As John mentioned earlier, our leasing spreads on deals signed this quarter were plus 7%. How we had we used our old methodology. It would have been plus 6%.
Now, let's discuss our updated 2022 guidance.
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 information and market intelligence as we know it today any COVID-19 related impact of significant shifts in the economy, our market tenant demand construction costs and new supply going forward could have a meaningful impact on our results in ways not currently reflected in our analysis projected revenue recognition dates are subject to several factors that we.
Can't control, including the timing of tenant Occupancies.
With those caveats, our updated assumptions for 2022 are as follows.
As always though acquisitions are forecasted.
We continue to assume $200 million to $500 million of dispositions.
Development spending for the balance of the year is expected to be $500 million to $575 million.
A modest increase from our prior forecast due to the inclusion of our recently acquired Austin site.
We expect to commence revenue recognition for the remaining 51% of 333 Dexter by the third quarter and for 250000 square feet of life Science re developments by the early fourth quarter.
It is important to note that the prior tenants for 12, 400 high blocks and $46 90 executive drive our lifestyle three developments in San Diego moved out in the first quarter. So NOI at those properties will drop over the next couple of quarters before ramping back up in the fourth quarter. Since these buildings are now in the redevelopment pipeline. It does not show up in there.
Occupancy.
Year end occupancy is still projected to be 91%, 92% for the office portfolio and residential occupancy is projected to stay around current levels.
Same store cash NOI is expected to be between 5% and 6% a 50 basis point increase at the midpoint due to the strong results from the first quarter.
Putting this altogether, we project 2022 <unk> per share to range between $4 44 to $4 58.
With a midpoint of $4 51, which is a 6% increase compared as compared to our prior guidance.
The implied run rate in our new guidance is below the first quarter results due to the dispositions expected to occur over the balance of the year, which had a roughly 11% impact and from the two pennies of net nonrecurring items in the first quarter.
That completes my remarks, and I will be happy to take your questions.
No.
Thank you.
To ask a question today please.
Please press star followed by the number one on your title. Thank you Pat now.
Our first question today comes from Nick.
And Scotiabank.
Go ahead. Your line is now open.
Yes.
Thank you maybe sticking with the guidance I guess I just wanted to be clear on this so it sounded like there was you said a two penny nonrecurring item in the first quarter and so Scott guidance went up.
<unk>, so just trying to understand what.
Whats the difference the delta in the rest of the guidance raise.
Yes, so you can roughly break it up into three buckets.
It's about a third a third a third.
A third being the one time the net one time items that you outlined a third being.
The residential portfolio, which was strong in both <unk> and.
In the first quarter and the last third with sort of miscellaneous other include.
Including some earlier.
Lease starts and capital cap interest being slightly higher.
Okay. Thanks, and then I guess, maybe maybe a question for Rob or someone else just maybe an update on on some of the leasing conversations.
You're having in that.
Economy between some of the markets you're focused on.
Sure.
How youre doing next let me, let me give you a broad overview to start with just four points I'd like to make.
These points are tied directly to <unk>.
Kilroy portfolio, where we operate where all the top tier talent pools are located.
And where youre seeing a flight to quality, but the four points are.
As John said and in all cases leasing activity in our markets has improved and optimism is improving reentry.
It remains fluid.
Lastly, the third point is that American office workers are back to work at the highest level since the pandemic and Austin, our newest market is leading the way at 61% followed by Dallas and Houston.
So, Texas is really going to be a bellwether, we think for return to office nationally.
The last thing I'd say on this third point is that average occupancy for the top 10 metros in the U S. It's about 45% today.
And a lot of that has been impacted in the last six weeks by Easter Passover and extended spring breaks.
So that has affected demand we think the last point I'd make is that real estate executives that were speaking to at major companies are almost entirely consumed with bringing people back to work.
With various programs, you've probably read about Google having concerts at their campus.
Mountain view and other other schemes like that to bring people back to work.
I can go into individual markets, if you'd like.
Or it can stop there.
Yeah, that's great I guess, maybe just to follow up on San Francisco itself. So if you can tell us in terms of traditional office leasing demand how that's working and also how you think employers are looking at Silicon Valley.
They already have some campuses in Silicon Valley and.
If that's being used as maybe.
10 tenants workers can go to Silicon Valley has been some press about at least one company.
Saying that they could put employees into the valley. They don't have to go into San Francisco or lower if you want to go to the office goes the valley I guess I'm just wondering how latest feel on San Francisco proper leasing.
Okay sure.
So as of yesterday of Etfs.
Reported the tours are up 23% in the San Francisco February to March.
Just to give you a little color year to date leasing in the city was 732000 square feet 611000 of that was class a leasing 121000 of that was class B brokers said to me yesterday, if youre sitting on commodity space you are not busy if you've got quality space Youre acts.
Pretty busy in San Francisco.
Sublease space has dropped to about $6 5 million feet from a high of nine 4 million during the pandemic. So that's a positive.
John had mentioned Bart and Bay bridge crossings all of those.
Metrics are up.
Weekly bad swipe data from tracked by castle as it has.
<unk> increased over the last three months so.
We're seeing.
Good uptick in activity in the streets of few towards San Francisco three weeks ago, it's totally different today just in terms of how many people are on the street. How many people are in lobbies and that kind of thing and the last point on your question on Silicon Valley and the conversations we're having with real estate executives.
I would like to see I think we'd all like to see San Francisco and Seattle have higher physical occupancy than we have today, it's hovering around 24, 25% for both markets.
That said as you know Silicon Valley has been extremely busy but the real estate.
State executives were talking to are making plans for San Francisco and are bringing people back to work that has not translated into big Tech, making big moves, but as I made in my the point I made in my four points I think most people in those in that world are really focused on getting bodies.
Back into the office. So that then they can start projecting what their demand really is.
Thanks, Rob appreciate it.
Yes.
Thank you Nick our next question today comes from Brian <unk> from Evercore. Please go ahead, Brian Your line is now open.
Alright. Thanks.
So for the new development in Austin.
Theres, obviously, a lot of development going on there.
Can you maybe just walk us through what your pitches for prospective tenants there and John you mentioned the light rail just curious what's the immediate amenity base like there and what's the walkability to the demand.
Rob do you want to take the.
The Pittsburgh sure were slower in the process of making.
Yeah.
Yes.
So we're really excited about the stadium district, the domain clearly domain proper gets a lot of attention because of the shopping mall.
Surrounds the existing office buildings, but the stadium district is an up and coming neighborhood with the huge amount of residential coming in as John pointed out in his comments. The light rail is going to be a major impact to connecting.
The whole area domain as well as stadium district to downtown.
And we actually see it I always like to look at marketing and how we play off of different market in.
In different ways, and we actually see the stadium district is a real opportunity for new amenities and improved amenities less congestion in and around our project. There are some competing mixed use projects that are.
Relatively close and timing to ours that will include hotels restaurants, and that sort of thing. So we think with the stadium there and their food and beverage programs Theyre conference centers that kind of thing what we're planning on site as well as what's happening in the immediate neighborhood.
We're going to have a very vibrant.
Market, there and keep in mind from when we put shovels in the ground to deliver space, it's probably a two year process. So things are changing quickly in that sub market.
Yeah on the light rail.
Rail lines about 32 miles long its going to have nine stations.
On the call a station at the stadium is scheduled for completion in 2023 is fully funded.
And downtown through the domain and up to northern northwestern often often what I understand is that that's going to be complete somewhere in 2025 pursuant to the city.
Does that slip I don't know.
Okay and then just.
Boston CBD.
Rob can you.
Talk a bit more about the leasing efforts at India tower.
When do you think you get the remainder of that building leased and what are you hearing from the tenant's perspective tenants there.
Sure.
So the CVD as John mentioned in his remarks Facebook to over 650000 square feet recently that deal by the way just to give color had been in discussions for almost four years. So that is not something that just popped out.
Nowhere it took a long time between the pandemic and meta really putting into paper.
Tick Tock took the balance of the largest class a space in that sub market.
We're averaging about tour every seven to 10 days we have.
I'd say a handful of tenants that are over 100000 feet. Each that were in discussions with looking at the space.
And the space, if you've not been to it you should see it it just shows extremely well we've got.
Beautiful lobby as you would expect from a Kilroy project beautiful very clear.
<unk> views around almost all source of the project and our floor plates at 33000 feet.
All sorts of different.
Tenant types, whether its professional services or tech and by the way just to give a little more color of the tenants that I said, we're talking to.
Or a mix of professional services and technology. So it's nice to be able to fish in a couple of different parts. If you will.
Hey, Rob you pointed out what we're how we're positioned with regard to the square footage we have left versus the other class a.
And the market that are available in the same timeframe.
So we have the largest contiguous block of class a space Trophy space I would say in the market right now and for the perceivable future. So we have over 200000 feet right now.
That were marketing and as I said earlier, we've got more interest than we have space.
So we're really focused on trying to do the right thing for the asset I'd also say.
Without getting into our competition, who they are.
Some of the transactions that have happened.
Before we close on indeed, and during our lease up of indeed.
Have been at rates that were just not.
We're just not going to.
Transact at those levels.
Alright, thanks very much.
Thank you Brian .
The next question today comes from John Kim from BMO. Please go ahead, John Your line is now open.
Thanks, Good morning.
John and Ralph gave examples of tech companies leasing space in our return to office.
Driver, but on the flip side, the NASDAQ is down 20% from our fleet.
A lot of debate.
Our company.
About 60% or more has that had an impact on either the leasing activity.
Activity or more of these companies, putting sublease space on the market.
I'm going to take that Rob Yeah. This is Rob John .
We're not seeing that and if you look nationally at the requirements that are in the office sector right now even in Midtown Manhattan.
It's quite robust from Fang companies.
We're just not seeing a let up and I would say, particularly in Seattle and Bellevue, where there are some things going on that are not signed yet.
There's going to be more happening out there is San Francisco.
Activity is picking up as we've said and larger deal size is picking up we're just not seeing the $5 million million foot requirements that we saw in 2018 2019, yet, but as I've said on previous calls and investor meetings hiring has continued unabated for.
All these tech companies and.
It's just a matter of fact that theyre going to need office space to fill.
Two houses employees I think one thing I would say that was really interesting was an interview with Eric.
Eric Schmidt the former CEO of Google, where he was quoted saying I don't know how you build a great management team virtually virtually tools are not the same as informal networks that occur within a corporation. So we're seeing from Fang as well as the Companys below thing.
There is interest continued interest in San Francisco and in the other markets, where this top tier talent pool that's available.
Okay and looking at your office lease exploration.
Very manageable.
123, or 11% of your release.
Expiring square footage.
Whats a reasonable expectation of where that goes to by the end of the year.
As far as what you had addressed this year.
I don't want to I don't want to predict but I can tell you.
We're in.
<unk> on the bulk of the space and.
A lot of the interest came up.
Starting in February and I would remind everyone. We still had almoner kron floating around in January and early February so a lot of the conversations we're having on our 23 explorations started in earnest in February a few of them.
Couple of them were before but we're under discussions right now with the bulk of it so I feel.
Sure.
Knock on wood I feel like we will be.
To be successful.
Thank you.
Okay.
Thank you John .
Our next question today comes from Jamie Feldman from Bank of America. Please go ahead, Jamie Your line is now open.
Great. Thank you.
I appreciate your comments on Fang requirements being robust can you talk more about the maybe the smaller tenants in the market, where clearly it sounds like.
Capital is starting to slow from like the venture capital side.
And also youre leasing volume in the quarter.
Decline well below your trailing four quarter average.
Is there something you can point to for that and do you think it starts to pick up in the future.
Yes, let me start with the latter question first Jamie.
I would have loved to announce deals that we have in the works for the first quarter, but we're just not going to.
Do what I would call silly things to get a transaction done.
We are always.
Pain our discipline.
Negotiate.
The best deals we can for ourselves, but also try to make it mutually beneficial. So we're close on some things John gave you the number 350000 feet.
Our late stage discussions.
Don't want to give more color on that but.
More to come that I feel confident about.
First question was I'm, sorry, what was that it was on.
Just I mean, you talked about saying, perhaps smaller users.
A smaller and smaller so again it depends on the market. We just we have six.
A 6000 foot transaction happening in Belvieu right now.
That should be signed any day now.
On the smaller side Hollywood has been.
Then slow in the 30000 square foot and below.
Tenant size.
In San Francisco, there's quite a bit of activity tour activity in that size range of 15 to 30000 feet.
And Austin sort of the sweet spot tenant if you will in the CBD is about 15000 feet and tour activity there has been very robust.
Both from Tech as well as professional services so.
We're not seeing a letup in fact I've seen over the last six to seven months.
An uptick in smaller tenants, taking space and a lot of those as I said earlier in those numbers for San Francisco.
These are relocations to better space.
Upgrades, yes, yes, I would add to that you didn't mentioned San Diego, we don't have any space. I mean, we have 2100, kettner where were not really wanting to do smaller deals.
Other than as they back feel bigger tenants that we're working with and the del Mar area. As an example, we don't have the space, we have tons of demand through the smaller tenant.
Tenants four.
For high quality space down there, but we just don't have the product.
But I think it's a good question you ask Jamie because smaller space I think there is lag at least a lot of areas. What we're seeing in off it would be a good case, we're seeing a lot of financial services.
The C type companies.
Law firms and whatnot that are both big and smaller ones that Mark as you know is is booming.
And it's attracting a lot of new folks to the market they want to.
Get there or in Austin waters.
So that's been an area that has certainly lagged the smaller tenants.
And thats coming back.
The thing that I would say that.
Across the board and Rob made a comment about this about what's happening at San Francisco with roughly six seven.
Our 85% of the.
Stuff that was leased in the first quarter was all high quality space.
The chicken, it's all about high quality space its all about.
The best locations and best product and we think we do very well when we look at our portfolio on that score.
Thanks, Dan I appreciate it.
But when you think about a pullback in VC funding, whether its life science or tech I mean, how exposed you think your portfolio would be to that.
Delayed decision, making that those types of tenants or even failures by those types of tenants.
Yeah.
Well, it's hard to predict.
There's been there's been.
All time highs in VC funding and it's backed off a little bit but still if you look at it over a 10 year period, it's still going to be.
Track would be one of the best years ever I don't know how to predict that.
We obviously talked with whom of RBC friends about what they're doing they all seem to be very busy, but I don't know how to predict.
Of that Jamie.
Hey, Jamie this is Elliot maybe just add onto that.
John's point, when we look at the trends in VC funding Youre right and that they're down from 2021, but I think it's important to keep the context of 2021 was a record year of VC funding by a multiple of two and so if we're down a little bit in 2022, but we're still at.
The second best year by a meaningful margin, we think that's a healthy environment for companies, even if it wasn't as good as last year because their availability to capital is still quite strong.
We think when we take a step back and look at kind of the bigger picture trends as John mentioned things are still in pretty good shape.
That's very helpful. And then just shifting gears to the asset sales can you just talk about.
What kind of data you are seeing for assets with the buyer pool looks like and then also.
Comments on quality do you think there is what we should expect to see kilroy continuing to shed assets.
Improved portfolio quality, even more in the coming years.
Joe you want to take what we're seeing in the way asset sales and so forth and I can take the quality afterwards.
Sure So Jamie similar to kind of on the leasing side I think that on the capital markets just with the change in interest rates. That's happened over the last six weeks or so the volume of asset sales has slowed as everyone tries to figure out where things are going.
It's interesting because while the 10 year is don't know where it is today, but call it high twos.
On a relative basis. This is sort of where we were in 2018, so it's not the absolute level of <unk>.
Where the tenure is that it's getting people pause, it's just the volatility and so volume has not been as high as it's been kind of even at the end of 2021 in terms of the trades that have happened.
Theres still plus or minus in the same ballpark is where asset values were.
At the end of last year.
So volume a little bit lighter, but asset values or.
Plus or minus is similar.
On the quality side of things.
You asked.
Would we expect our our.
Quality to improve even further well I think I think most people know.
In terms of scale I think we probably have the highest quality portfolio.
Vinny.
But in the country.
So it is.
We're in pretty good shape on the quality spectrum in terms of what we sell does that mean.
<unk> impact.
The overall quality, maybe a little bit.
Sure.
And then of course, you know our development at all.
Top tier quality, so I don't I.
I don't know how to say that I mean, I don't want to signal exactly which buildings, we're thinking of selling.
But we're very focused as we have always been on where to be.
And physicality how is it building set up to perform for the long term, whether we can make any more value by owning it versus selling it and using that for.
For alternative investments.
That's going to continue to be the way we operate the company.
But I think we are.
From a qualitative standpoint, even though assuming the assets we have might be somewhat older they've all been.
By and large gone through major renovations over the last few years. So I think we're really positioned.
Hi, Mark and higher again, I think anybody else on a portfolio basis.
As to the quality standard so.
Can't give you much more than that Jamie.
I guess, maybe a better way to ask do you see.
Like the low end of the range of what you would want to own long term has changed during the pandemic I know youre always recycling, but can.
Could you kind of raised the bar on the long term keepers.
I I'd say at the margin, yes, obviously the.
It's been well written about by all of you folks and others.
It's the brokerage the real estate brokerage community or never.
At the trend too.
High quality assets has been accelerated by Covid.
We were identifying that over 10 years ago.
In conversations like this or that I.
Spoke to that or others might have spoken at the industry groups.
Signal long.
Before that I think I coined the term not your father's office space and that's been used pretty widely by our peers as well.
What we do is really to differentiate ourselves from other providers and a number of ways you tour a bunch of our assets, so I'm not going to get into describing at all and we always look to how do we differentiate with the with the understanding that we do so to.
Jack and retain and to create long term value and not just do a deal where building is great today, but might not be great. After the first tenant.
And you've seen US do that for example, the 300000 square feet or so down in San Diego that we converted to life science.
Those are all buildings that were had the physicality permits lifesize added fluoride floor loading and structural and so forth that is necessary for those kinds of assets that we were very easily able to convert at relatively modest numbers those spaces to accommodate life science. So we take a look at.
Not only the existing use.
It might become in the future we look at what the life is after the existing tenant obviously the market all of those factors get into it.
I think you'll continue to see you and others will continue to see that if we have the highest quality portfolio today, we'll even have a higher quality portfolio tomorrow and the year after tomorrow.
Okay. Thanks for everyone's time.
Thank you. Our next question today comes from Manny Korchman from Citigroup. Please go ahead Maam. Your line is now open.
Okay.
Hey, everyone.
I mean.
I know you don't include acquisitions in your guidance, but are you actively looking for acquisitions in the life science side and if so are those strictly <unk>.
Land deals or would you look at other assets to either convert or.
Add to your life science platform.
I'll take that one John maybe how are you doing.
We look at everything.
Well most everything.
At least.
Our markets, we've not been able to find any assets.
That we'd like to convert two life science that makes sense to US you certainly as I've said many times before on these kinds of calls you.
You can make.
A lot of buildings life science.
In terms of the physicality that question is that people want to be there can you make money and most of what most of what we see going on we don't know how people make money.
There are a lot of smart people out there and they may have a much better formula one in particular building, we do but we have not seen anything to buy.
We look at everything from a development standpoint.
Been very at we've been.
From a conversion standpoint in our own portfolio, where thats really well located where people want to be in the buildings lend themselves to being converted we do that we think we have more of that.
And scale some of it you can't get to right away, because it's being occupied by others.
And then from it at all in that standpoint.
We have always loved about development, whether its office or whether its life science.
We can develop best in class assets that we think just get better and better with time as rates go up and demand goes up and so forth. So our focus has been on the development side. Because there you have something that really is attractive to the user that has all the bells and whistles the amenities and all.
The things that they are looking for so our focus is going to be far more on development that doesn't mean, we won't look.
At opportunities to acquire <unk>.
<unk> life science or to convert existing assets. We just haven't found anything that makes financial sense to us.
Thanks for that are you are you only looking in your existing markets.
Against this anywhere in the life science side or are you looking for new markets there as well.
We look at a lot of different things, but I'm not going to tell you any particular markets that we're looking at but I don't want competitors now, but I can tell you there's nothing active in our radar about lifestyle and different market today.
Alright, thank you.
Thank you. Our next question today comes from Caitlin Burrows from Goldman Sachs. Please go ahead, Kevin Your line is now open.
Hi, there.
Maybe just continuing on the life science topic, we've heard that life science development construction costs and lead times are being extended as delivery of key materials systems and generators are taking longer.
Seeing any impact TR and process life science projects are your plants at summit Santa Fe.
Yeah.
We have not Caitlin.
We have <unk>.
<unk> prices and delivery schedules mapped out on everything that we start before we start does that mean something could happen sure things happen. All the time, we have a very insurance.
<unk> management group and our.
And our construction development team.
And we deal with that stuff all the time, it's true that construction costs have escalated takes time, it's true that there are some things that are.
Our longer lead.
And I think this is going to be an issue for a lot of folks that are developing or thinking about developing if you own tons of land.
You got a long delivery schedule and you've got a needs to develop soon because I'm.
I am talking about the private people that.
The developer Luiz.
I don't think Thats, a good place to be we don't have to develop anything.
Right away, we can take a pause if we want and we're going to measure the market and when we measure the market that's not just demand, but it's construction costs for example up in Bellevue right now in Seattle construction costs have gone up are greater than they have in most other markets in the country and move when you think about Amazon is doing poorly.
Square feet and others are doing millions of square feet and there's only so many contractors and subcontractors and so forth are all busy as heck, we are a development site up there.
<unk> six O, but it's a couple of years before we can start it anyway.
And if we had already to start today, if we had all the approvals and all the rest beyond.
We're seeing the market, we would say that makes no sense to start today, because you've got to let some of this stuff.
Get through the system and get back to better pricing, so long winded answer but.
We we really pay attention to this stuff.
Start things without having a GNP price, we do a heck of a lot of due diligence on our general contractors and our sub contractors. That's what people have come to expect from Kilroy. That's what we do we're very rigorous and even more so today.
Got it Okay, and then I think early on you had talked about how there was the one I think it was expected.
Vacancy.
San Diego I was wondering if you could talk about the leasing activity our expectations for that vacancy that.
Occurred in the quarter at one of the Silver Springs.
<unk>.
Sure.
Sure.
So just to give some color the 56% I 15 corridor is the area.
Where the San Diego vacancy is but that is a corridor that has been.
I would say evolved to where you see life science activity happening there is a 500000 square foot.
Life Science company that signed a lease out in that corridor in 15.
And as you go North you have.
Several of the <unk> companies in the market. So we've been.
<unk> engaged with a variety of companies on the space, we have I've got nothing to announce as far as we're going to sign something eminently, but the activity is good at this space shows very well and.
Actually the location of it is.
So oriented towards $56 15 that it's probably the first stop is you go into that corridor. So.
We're going to do fine there, we just need to get big tenants, making decisions.
Got it thanks.
Thank you gentlemen, our next question today comes from Vikram Malhotra from Mizuho. Please go ahead. Your line is now open.
Hi, Thanks, so much for taking the question just wanted to get your thoughts on this what this quality divide and say San Francisco or the Bay area May eventually due to where rent differential exists between these two groups and maybe even values and then is that an opportunity for kilroy, but maybe.
Look the redeveloped value add property and create sort of a.
That said longer term that fits into the portfolio.
Let me start with that.
This is John .
There's a lot that's got to play out until we see the.
Until people start to digest they are back to work activities and how people are going to use space and what that's going to translate into remodeling space where demand for space as Rob pointed out in his remarks.
It's hard to say.
Sit around.
We look at various areas, we say, yes that site as well located it could be a great redevelopment play, but we're not acting on it right now I think we've got you know we have a lot on our plate right now with regard to leasing activity. We have some buildings, we want to sell we've been active in Austin, we want to grow in that market.
We're getting everything entitled it isn't entitled and getting entitlements are.
For a range of uses and so forth. So that we have a lot of optionality.
We're not really looking at.
Right now in a serious way towards acquiring either companies or properties with regard to converting.
Well, we in due course, we always have an eye on these things but.
I have to tell you we're not looking in earnest.
And the quality divide okay that material.
But the quality of the VI as I said in my comments earlier to somebody else's question.
It's never been more pronounced COVID-19 has done nothing but accelerate those trends I would not want to own commodity office space.
Or have it be in locations, where people don't want to be I think that it's losers game.
Thank a lot of people are going to get hurt and Rob can give you more color. If you like with regard to the rent differential being on the demand differential for high quality versus commodity space and Rob maybe you want to make a comment on that.
Sure.
Just to add color to what John was saying and I'll talk about the San Francisco's.
Everyone likes to hear about the city class a trophy rates are higher right now than they have been pre pandemic.
Ken Thats class, a view space and Theres very little of it it's <unk>.
Right now less than 8% vacant in that sub market by contrast, and let me let me point out two things there's sublease space and then there is direct space, which is also a differentiator, but right now theres probably at $15 a foot gap.
Between.
Class a rates and.
What I would call class a minus to B rates and then that gets further impacted when you look at 43% of the space that is sublease space on the market has a term.
About two and a half years on them.
That's interesting and you can see where it.
And eventually the caps that goes out and what this means for the value gap as well versus.
Sort of.
Pre COVID-19 level.
Just maybe maybe one more.
Maybe.
Elliot can you just clarify for us.
Two things on the expense side overall expense.
I don't need changes in the Opex.
Outlook for the balance of the year.
Any any puts and takes there and remind.
Remind us on the interest expense side.
I know there were changes the offline, but I just want to make sure.
What are you factoring in for just the higher rate environment.
So nothing on the Opex side to think about I think you maybe referring to how it was up a little bit sequentially and are reimbursements for correspondingly up a little bit. So there's really no notable change there.
On the interest expense side, we have no variable rate debt, we have no maturities for.
The balance of this year or next year as we said until the end of 2024, so there really aren't a ton of moving pieces there.
I alluded to earlier, our cap interest is going to be a little bit higher I think last time, we gave a range of $70 million to $80 million, we're probably trending towards the higher end of that range.
And Thats a function of our Austin project that we acquired but Thats really the only moving part for this year.
Okay.
Yes.
Okay, Great and then just sorry, one one metric I was wondering if you had.
We know obviously, what the sublet rates are across say the city or the Bay area.
I'm just wondering in your own portfolio do you have a sense or is there anything out to sublet the bank.
I mean, theres some theres nothing material the biggest sublease that we had in our portfolio has been absorbed it was at 350 mission.
Both the <unk> and sephora absorb that space and again, it's an example of in both cases those companies moving from.
Lesser quality poorer location to stronger class a asset.
But but.
The asking rate and the transactional rate for sublease space.
It's all over the map it really depends on the motivation of the sub lessor and in most cases sub lessors are just trying to reduce expense. So if they're not going to hold out for an extra $5 or $10 a foot.
They want to move the space most cases, they've already written it off.
Great. Thanks, so much.
Thank you Vikram.
Next call comes from our next question comes from Blaine Heck from Wells Fargo. Please go ahead. Your line is now open.
Alright, great. Thanks, just one for me here, probably for Rob can you give any more color on leasing progress at <unk> phase two I know you guys still have a lot of time until completion, but are there any conversations you guys are having now that I think that project has gone vertical.
Yeah, Hi, Blaine.
It's interesting similar to Austin, we're doing presentations Jonas Vos, our head of construction or development are doing presentations every seven to 10 days with users.
Tour activity has really picked up pretty dramatically in the last five weeks.
Some of that activity involves entire building in one case.
Some of it is just.
A floor multi tenant kind of scenarios.
Demand in the market still remains very strong at $3 5 million square feet.
And activity for space, that's ready to go meaning lab space that's built out.
Or that's further ahead of us in the construction cycle.
Continuing to lease and do well so.
It's been very active.
And we will continue to we think <unk>.
The increase over the next over the summer.
That's helpful. Thanks.
Thank you Dan. Our next question comes from Patrick <unk> from PCB. Please go ahead. Your line is now open.
Hi, Thanks for taking my question can you guys. A quick one for me can you just kind of on a physical occupancy and how that's been trending and just trying to get a better sense of return return to the office trends. Thank you.
This is Rob <unk>.
Touch on that so as I said in my comments, let's start with Austin physical occupancy. If you are asking kind of market by market Austin and the lead is 60%.
San Diego is about 50% and that's at our one Paseo project del Mar you could actually argue it's probably closer to 60% based on the last.
So.
La and San Francisco, and Seattle are all and again it depends on the Submarket you can't it's very dangerous to generalize about the market as a whole but.
La San Francisco and Seattle are all in the.
25% to 30% range, but again its very.
Bellevue is going to have a much higher occupancy rates than <unk>.
Seattle and it's all a function.
The good news is as John said in his comments there is a concerted effort by tech companies to bring people back to work and Theyre doing that.
That said there also are sensitive to the talents that they've hired and not losing them so theyre being.
Gentle I guess in terms of bringing people back.
Got it that's very helpful. Thank you.
Thank you. Our next question comes from Daniel <unk> from Green Street. Please go ahead. Your line is now open.
Great. Thank you just another follow up on Kilroy Oyster point.
Oyster point they too.
I'm just curious how the underwritten there have changed.
You mentioned earlier on the call the fixed cost to develop the project.
I assume rents has run pretty significantly since you guys broke ground.
Yes. This is John .
Rents have gone up there at all time highs or quite a bit higher than we forecasted.
I'm unwilling to say, what we think our new yields are going to be but I think we're going to be better than what we initially.
Yes.
We'd achieved but more to come but youre right the rents are up.
Uh huh.
I don't recall exactly what we underwrote too, but they were up.
Somewhere in the neighborhood of I don't know.
Tend to drop somewhere 10, plus dollars a square foot per year, yes.
I mean, if you go back to our <unk> and stripe deals rents are up.
Over 25% from when those deals were done.
And there is no there's been no letup in asking rates increasing.
Sure.
Got it. Thanks, that's helpful and then just a curiosity question.
<unk> seen in San Diego Life Science right.
Pretty dramatically the last two quarters.
Just curious if you think San Diego or battery reached San Diego Life Science rents will eventually reach parity with South San Francisco and Seattle or do you think there will still be.
GAAP between those markets.
Yeah.
I think big.
I think in some of the newer deals that ive heard about.
They're breaking $7 triple net.
So that's what $84 in the rates.
Yeah.
South San Francisco, and some cases are higher than that but I think they are there I mean, it's it may be different as you get further away from UGC.
From.
From Torrey Pines, you may end up with a little bit.
A little bit less I don't know, we've underwritten so considerably less.
In regards to Santa Fe Summit.
But I don't think there is going to be much differentially.
I think there will be speaking of now I'm speaking a really great product.
Really great locations.
It is definitely going to distinguish between stuff thats not as good or not as well located for sure. So that's you got to take that with a grain of salt.
Got it.
Thanks, Sean.
Thank you. This concludes today's Q&A session.
I would like to hand, the call back to Bill Hudson.
Well. Thank you so much and thank you everybody for joining our call today. We appreciate your continued interest in <unk>.
Have a good day.
This concludes today's call and enjoy the rest of your day you may now disconnect your lines.
Yeah.
[noise].
Yes.