Q1 2023 Kilroy Realty Corporation Earnings Call
Good afternoon, and thank you for attending today's Kilroy Realty Corporation first quarter 2023 earnings Conference call. My name is Daniel and I'll be the moderator for todays call all lines will be on mute on the presentation portion of the call with an opportunity for questions and answers at the end.
It is a bike to ask a question. Please press star followed by one on your telephone keypad. It is now my pleasure to hand, the conference over to our host Bill Hutchison Senior Vice President of Investor Relations and capital markets. Bill You May now proceed.
Thank you good morning, everyone. Thank you for joining us on the call with me today are John <unk>, our chairman and CEO , Justin Smarten, our president Rob <unk>, our chief leasing officer, and senior adviser to the chairman and Elliott Trencher, our CIO and CFO .
At the outset I need to say that some of the information we will be discussing during this call is forward looking in nature. Please refer to our supplemental package for a statement regarding the forward looking information on this call and in the supplemental.
This call is being telecast live on our website and will be available for replay for the next eight days, both by phone and over the <unk>.
Internet.
Our earnings release and supplemental package have been filed on our form 8-K with the SEC and both are also available on our website.
John will start the call with our first quarter highlights and then Elliot will discuss our financial results and provide you with our updated guidance then we'll be happy to take your questions. John . Thank you Bill Hello, everyone and thanks for joining us.
First and foremost while we are seeing strong signs of the economy and remain optimistic.
We would like to acknowledge that we are still facing cyclical and secular headwinds.
The macro environment today.
I defined as.
It just lack certainty.
Sentiment is challenged in financial stocks, such as Silicon Valley Bank and the crisis was created really there to continue to dominate headlines in many areas.
From a real estate perspective, we haven't seen the implications of the current economic backdrop translate into near term obstacles.
There's been a reduction of liquidity in the investment sales market.
Downward pressure on leasing fundamentals as tenants delays space requirement decisions and a pullback in financing and investment activity within the banking and venture capital community.
However, despite these macroeconomic challenges we are proud to announce that we delivered a strong quarter and record <unk> per share Elliott will go through the quarter in more detail when he gives his remarks.
Shifting to our markets, we would like to highlight encouraging trends.
And what we see are seeing with our boots on the ground at each of our regions.
As we discussed on prior calls physical occupancy in our portfolio continues to trend up.
And the share of job postings that are remote has been trending down.
Boston and San Diego continue to lead the way with respect to physical occupancy with over 70% at quarter end. These markets continue to edge closer to pre pandemic levels.
San Francisco, a region, which admittedly has been lagging in regards to return to office saw its highest quarterly increase of over 6% in physical occupancy since the start of the pandemic.
<unk> spread return to office announcements from top tech firms have has translated to noticeable increases in physical occupancy in our San Francisco portfolio and we expect this trend to continue.
Los Angeles, and Seattle, both saw positive physical occupancy trends during the quarter, increasing to approximately 50% and 40% respectively. This reflects another encouraging update for our markets and we anticipate this trend to accelerate as more return to office mandates are implemented.
The anecdotes back up our portfolio data recently J P. Morgan told senior bankers to be in the office five days a week Amazon <unk> policy is set to begin next month and others are following suit. Many companies are realizing the inefficiencies of remote work and are starting to demand.
<unk> as Amazon CEO , Andy Jass. He wrote in his recent shareholder letter, we become convinced that collaborating and inventing is easier and more effective when we're working together and learning from one another and I can tell you that kilroy, we feel exactly the same way.
The actions of these companies and others across across section of business sectors, including Apple Disney Starbucks Deloitte capital, one and many others highlight the long term importance of the office had increasing productivity and enhancing collaboration and culture.
As returned office continues and companies have real data to support the power of in person work our portfolio is well positioned to capitalize on the resurgence of demand and flight to quality dynamic.
As evidenced since the end of the fourth quarter, we signed approximately 338000 square feet of leases with an average term of approximately five years and many of those we had no capex and Austin, we signed another lease at Indian Tower for 20000 square feet with the National wealth management firm, bringing our occupancy to.
74%, we have had great touring activity in the building and demand for space and Indeed tower has increased over the last couple of quarters, which we expect to turn into good news.
We have also executed notable leases across our bay area of San Diego portfolios in San Diego, We leased 65000 square foot new lease with Mediatek USA and a 25000 square foot renewal with Intrepid studios in the Bay area, We leased 50000 square foot new lease with <unk>.
And a 65000 square foot renewable renew with 23 in May.
In addition, innovation continues to happen in our markets.
Ecosystems on the West Coast took many decades to build and continue to have all the ingredients for success Engineering computer science and medical students are attracted to world class universities, like Stanford Cal Berkeley and UCSD.
Most prestigious venture capital funds or a headboard Menlo Park and the biggest technology companies in the World are based in San Francisco and Silicon Valley. This recipe results in the formation of new innovative companies, such as Fintech, social media self driving cars and more recently artificial intelligence.
The Bay area in particular has been the birth place of many of these businesses.
<unk> is no exception as over 40% of AI companies are based in the region. While it's still early days in this translating to demand for office. The bigger takeaway is innovative companies still want to be in the in the city and San Francisco Bay area.
Moving on to life Science, there continues to be long term themes that have prevailed, which bear mentioning 2013 marked the beginning of a 10 year run which radically shape life science.
As we see it today the critical driving factors that define this burgeoning industry included aging population improved FDA approval processes rapid M&A activity and the availability of funding to capitalized research and development activities.
After record years of venture capital funding in 2021 and 2022. These funds still maintain large levels of dry powder with some deals getting done but not all at the clip we have recently witnessed.
That said, we believe the increased capital will be eventually be deployed as business conditions improve and we will provide a powerful boost to the life science ecosystem.
The acceleration of technological advances within the life science space as creating breakthroughs.
Pushing the frontier of what can be accomplished.
Sciences, such as gene therapies.
In a in immunotherapy are in the midst of rapid change that will redefine the art of what is possible.
So we believe the convergence of artificial intelligence and technology companies focused in the life science space will move the needle.
Even further these.
These types of hybrid companies are in their infancy and have yet to fully mature.
He already has high conviction in the underlying long term life science fundamentals and we'll play the long game as we increase our exposure to the sector. As a reminder, life science will make up more than 20% of our NOI. After co op phase II delivers and over time, we expect this number to grow to over 30%.
As we develop and lease future life science projects.
Zooming out to our platform at current mentality. We Kilroy has built a company that is positioned for both offense and defense. This is not accomplished overnight, but it's been a core principle of our strategy spanning across cycles.
As we sit here today Kilroy is one of the strongest balance sheets in our sector headlined by a moderate leverage profile robust liquidity and limited term debt maturities. Our portfolio is young and modern comprised of high quality well located assets that we believe will prove to be resilient over time.
Lastly, the management team at Kilroy is cycle tested.
Managing through periods of economic uncertainty and has a proven ability to take advantage of market conditions as they unfold we remain opportunistic.
Ah, rather opportunistic and our ability to create value for our shareholders as we have done through previous cycles over time.
As we think about how to move through the current downturn.
Like to share with you how we have positioned the company in this current environment.
In previous downturns Kilroy has emerged stronger.
Case in point the steps we took during the great financial crisis of 2008 2009 led to a total transformation of the company, we enhanced the quality of our assets and.
And pursuit product expansion to new high growth markets, creating significant value for our shareholders.
We are not done yet we are focused on the following actions to ensure that we emerge from the current downturn and a place of strength.
Maintaining a strong balance sheet and opportunistically evaluating alternative sources of capital to further enhance our already significant liquidity position, providing certainty to our tenant base in today's environment for.
Prospective tenants are increasingly evaluating landlord capabilities and financial strength in essence tenants want to know that their landlords have the financial capacity to fulfill their needs and obligations, while being able to provide an exceptional level of service.
Positioning our assets to be top tier choices. When the time comes for tenants to making leasing decisions is another important focus if there are two choices in the market or are there may be more we intend to be one of the top three.
Heightening, our focus on driving organizational efficiencies and reducing our capital spend where appropriate.
And positioning the company for its next 2010 moment.
Periods of change always present opportunities and we intend to be opportunistic when the time is right and.
In summary, our strategy is based upon maintaining best in class real estate disciplined capital allocation, a fortress balance sheet and the team to execute.
We are adhering to this principle.
But rather to the simple effective approach over multiple cycles, which has given us the ability to play defense on the downside, while maintaining the wherewithal to be opportunistic when it makes sense.
And lastly, as I'm sure you all saw last month I announced my retirement effective at the end of the year 2023 marks my 28th year as CEO of Kilroy Realty and 54 at the company, including its predecessor.
I've dedicated my career to Kilroy, and I'm pleased to be able to retire with the company, having the best port portfolio amongst our peers and impressive capital allocation track record a solid balance sheet and very importantly, a deep and talented team.
I am confident we all have that we have the pieces in place to continue executing at the level of investors have come to expect from Kilroy and as a significant shareholder I am incredibly invested and the continued success of the company that completes my remarks, now I'll turn it over to Elliot.
Thank you John .
<unk> was $1 22 per share in the first quarter, the highest quarterly SSO in the company's history. This is up roughly <unk> <unk> net from the prior period, mainly due to a full quarter of revenue from indeed lease in Austin.
Our results included both positive and negative nonrecurring items, which more or less offset each other.
On a same store basis, the first quarter cash NOI was up an impressive 16%. This includes roughly $12 million of tenant restoration payments tied to two properties. Excluding this nonrecurring revenue same store NOI would have been up about 9%.
The strong same store is due to free rent burn off at phase one of <unk> in South San Francisco and higher parking income.
GAAP same store NOI is up roughly 2% after adjusting for the nonrecurring items.
At the end of the quarter, our stabilized portfolio was roughly 90% occupied and 92% lease.
The decrease from the prior quarter was due to previously disclosed move outs, including Directv is downsizing and I'll begin though.
Leasing spreads in the quarter were negative 4% on a cash basis, driven by one lease in San Francisco. If we were to exclude this lease spreads would have been up approximately 8% on a cash basis.
Net debt to first quarter annualized EBITDA remained about six times I want to emphasize that we have no debt maturities until December of 2024, and limited interest rate exposure with over 90% of our debt fixed.
As John mentioned in his remarks, our liquidity remains strong at $1 6 billion, which is comprised of $330 million in cash $170 million in future term loan proceeds and $1 1 billion of capacity on our line of credit.
One modeling note during the last week of the quarter, we drew down $150 million in term loan proceeds in accordance with the terms of the agreement. So the first quarter interest expense run rate needs to be adjusted if you were trying to use that as a starting point to project the balance of the year.
Our capital requirements for the remainder of the year of $325 million to $425 million of development spend obligations for 2024 include a $425 million debt maturity in December plus any additional development costs. Our net liquidity is robust, but we will not hesitate to enhance it should.
<unk> opportunities present themselves.
Before discussing guidance I wanted to point out some additional disclosure in our supplemental on pages 14 through 16, we pointed out the four properties not in the same store pool consistent with our long standing policy, we add properties to the same store pool once they have been in the stabilized portfolio for a full calendar year. So these four properties.
We'll all go in at the beginning of 2024 as of the first quarter of 2023, the same store pool represented 93% of our stabilized square footage.
Now, let's discuss our 2023 guidance.
As always no acquisitions are forecasted and we continue to expect dispositions to be between zero and $200 million.
Our roughly 50000 square foot life science redevelopment at 46, 90 executive drive in San Diego was fully leased to Sorrento Therapeutics. However, they recently filed for bankruptcy and rejected the leases as a result, the building is now projected to enter our stabilized portfolio in 2024.
We anticipate drawing down the remaining $170 million from our term loan over the next two quarters.
As I previously mentioned development spend for the remainder of the year is expected to be $325 million to $425 million.
When factoring in the roughly $75 million of spend in the first quarter, the full year estimate of $400 million to $500 million.
Represents about a 10% decline in spend compared to our original projections.
There is no change to our expectations for same store cash NOI, which is projected at zero to 2% or average occupancy which is projected to be between 86, five and 88%.
We anticipate additional G&A costs of 8% to $14 million from contractual obligations tied to the accelerated vesting of shares in connection with an executive retirement outside of that there is no change to our G&A estimate.
In summary, our original <unk> guidance for 2023 was $4 40 to $4 six with a midpoint of $4 50 per share.
While most of our underlying assumptions are unchanged, we are updating our range to reflect the onetime G&A costs of approximately 10 cents at the midpoint. This brings our updated range between $4 30 and.
$4 50, with a midpoint of $4 40.
Were it not for the G&A adjustment, our <unk> guidance would have been unchanged.
To provide further clarity guidance implies average quarterly <unk> of roughly $1 <unk> per share for the balance of the year was <unk> 16, lower than the first quarter to bridge the gap on the 16th.
Subtract a net 10 due.
Due to lower 2023 occupancy, which factors in our move outs and move ins, including our west date move out in Seattle, which is effective at the end of April . We then subtract fixed for various other items, most notably the nonrecurring G&A costs and higher interest expense from remaining draws on our term.
Okay.
In terms of sequencing throughout the year, the second quarter will be higher than the third and fourth quarters, given one month of Amazon and the projected timing of drawing down the balance of the term loan.
That completes my remarks, now we will be happy to take your questions Danielle.
If you would like to ask a question. Please press star followed by one on your telephone keypad. If for any reason at all you would like to remove that question. Please press star followed by two again to ask a question. Please press star one as a reminder, if you are using a speakerphone. Please remember to pick up your handset before asking your question, we will pause here.
Please questions are registered.
The first question comes from Nick <unk> of <unk>.
<unk> Bank. Please proceed.
Thanks first question is just maybe you could talk a little bit more about.
Leasing traction right now in South San Francisco, and if we should think about for phase two there are oyster point.
Could that be a longer leasing timeframe now and I guess also from just from a sort of NOI commencement.
Possibilities you can just remind us let's say if you got a lease done at some point this year what.
When would be the earliest you'd start commencing some NOI on that.
Sure Nick this is Rob.
Let me give you a backdrop on south San Francisco.
First of all just to remind everyone. We have three buildings about 863000 square feet under construction. The buildings were purposefully designed for life science, but they can accommodate single users as well as multi tenant.
With the current situation with STB and just the general economy decision, making has slowed down no doubt.
Deal size has gotten smaller but right now in the market. There are 36 requirements that total about two 3 million square feet and I would say that's off from about $3 7 million square feet.
Prior to some of these negative economic headwinds that we've had.
Right now we expect deal size as I said to be smaller so think <unk>.
Average size right now is about 65000 feet or floors or 44000 feet. Some of the space. That's in the market right. Now is a single floor is only 20000 feet. So for US we can accommodate 44000 feet on one floor or a floor and a half for a larger tenant.
And the 60000 foot range that makes it much more efficient for the tenant so.
We've always looked at the project, we never really anticipated that we would lease all three buildings two one.
Single user we market that way of course, we go elephant hunting, but this is really going to be a multi tenant.
Floor by floor.
Block and tackle game.
There are large tenants in that market and continue to be despite what.
You may read in the headlines so.
The other thing I'd say is that there is more sublease space on the market.
Again, that's sort of and I am looking at sublease space.
Spread between share point.
And Oyster point and you know Oyster point is really the main and main of the market.
And Thats sublease space again is characterized some of its very usable, but again its 18000 feet.
<unk> thousand feet no no significant contiguous blocks of space in the market. So.
Long story short things will take longer but there are deals out there and.
Even with the VC funding environment Silicon Valley Bank wasn't the only lender to the venture capital World. There is a lot of private equity.
<unk> Blackstone and others that have moved into this space. So.
Although funding has slowed down I think everyone is just as John has said numerous times on our calls.
Don't have to make a decision today.
You won't make it.
With regard to note Nick this is John speaking.
Specifically two does it change our stabilization dates just to remind everybody that there are three buildings, they sort of stagger a little bit but the first building.
<unk> is schedule to be completed a shell.
In mid 'twenty, four and they sort of roll.
After that the other three and then it's a year theyre out from those dates that we anticipate stabilization pursuant to our pro forma we don't see anything at this point that changes those I mean, obviously, we will update if we do but we think those are probably still pretty good dates.
Okay. Thanks, John Rob just second question is on this idea of maintaining a strong balance sheet looking at evaluating some alternative sources of capital.
Maybe you could talk a little bit more about what.
That could look like and what's going to drive that decision making is it.
Ends up being a slower leasing.
Process at Kilroy point.
<unk>.
How would you consider.
Asset sales.
To raise some more liquidity as maybe the NOI gets delayed there or just how we should think about.
Potential sales jv's types of assets Youre thinking about and what would be the reason to do that.
Well as you know we have a tremendous amount of liquidity and a great balance sheet and very little debt Thats coming due early can give you the specifics.
But we're going to remain flexible as we always do we purposefully built the company to make sure that we had plenty of liquidity and a great balance sheet. If we ended up with headwinds and we do have headwinds and I've always said that we're going to play offense, but we got our first in order to play offense, you got to be able to play defense. So I think we're really.
Well position, we don't feel like we have our backs against the wall on any of that.
And as things sort themselves out we think that there'll be a much better functioning.
That market, which will help the buyer market.
As you know last year, we decided not to proceed with some of the disposition activity that we had forecast just because we felt the pricing would be better. If we waited. So do you want to cover Elliot I mean in terms of potential sources. There is a lot, yes and Nick.
Add to that when we were trying to convey is we feel really good about where we are liquidity wise, but that doesn't mean, we're just going to sit here and wait.
That we've gotten to this position is by being opportunistic we.
We didn't have to raise a term loan last year, we saw what we thought was an attractive opportunity and we pursued it and.
That's our mentality this year as well is that we don't feel compelled to do anything but as we evaluate alternatives. If there is something that's appealing and that could be on the secured side that could be on the unsecured side that could be on the sales side or the venture side.
If we see something that we think is attractive to help the long term situation for the company we will pursue it.
Thanks Ali.
One last one.
John I.
I think you outlined very well and congratulations on the.
In retirement.
You outlined the reasons why he decided to retire but I guess I'm just wondering the consideration to to make that announcement before lining up the successor.
Maybe you could just.
Outlining some of the thinking on that.
Yeah well.
At the board level, we talked about this a lot and the reality is that you can unless you have a specific individuals that you have designated to be in.
Internally or externally the person.
It can wait if youre going to go through a process, it's going to get out it is going to get out and there is nothing that doesn't get out today, probably the fastest way to get something around sell somebody it's a secret.
Hi.
And so.
So our view is we want to be very transparent we have some great candidates internally, we may find some great candidates externally.
In order for that process to go about efficiently. It means that we want our senior management team to be involved in and whatnot and.
It's just we came to the conclusion that it was best practices to be transparent. So thats, what we did and we wanted to make sure. We have plenty of time to go through the process and whatnot.
And.
We've come to know anything about kilroy.
Tell it like it is and we tell them as early as we think it's appropriate to do so and once.
I've made my decision basically it was time to tell people in.
Yes.
It's always kind of better suite, what's a great time to leave.
For me.
I have a lot of things as I put forth in my letter that I wanted to do in my life, including sport.
Bunch of grandchildren, ICM about once a year they all live in different countries and so I want to spend some time and.
I think this is a good process.
Yes.
Thanks, John I appreciate it.
The next question comes from the line of Georgia and color.
Of Mizuho. Please proceed.
Hi, Thank you for taking my question.
You. Please walk us to known move outs in the next 12 months and in terms of your top tenants with explanations in 'twenty, four and 'twenty five you'd see any early termination fees.
Yeah.
So this is Elliot we've touched on a few of the.
Top of the known move outs and will highlight the major ones we've got Amazon.
We've talked about it with data that's moving out in the second quarter, we talked about Pac 12, that's moving out in the Bay area in the third quarter.
And then riot, which is still TBD as the fourth quarter exploration in 2024, we have to move outs over 100000 feet, both of which are TBD in terms of how those play out and we have none in 2025 over a 100 K.
Yes.
Great. Thank you and just one more question on <unk>.
<unk>.
Given the high sublet space do you see any downside risk in terms of early terminations.
In Austin, our building is brand new in all the leases that are.
Either just started or will start when the tenant improvements are done and there is no termination rights. So I don't see any termination risk at all.
And I might point out that I did in my comments as John speaking by the way is that we've been exceeding our pro forma rents quite substantially there. So I think all systems are go for indeed tower.
Great. Thank you so much.
Welcome.
Yes.
Thank you. The next question comes from John Kim of BMO. Please proceed.
Thank you and good morning, and John Congratulations on building a great.
Great Real estate company.
I was wondering if you could discuss how involved you plan to be going forward with Kilroy. If you plan to remain as chairman.
And any characteristics you could share as far as your preference for a successor.
Somebody smarter than me.
Hi, Barbara I'm always a smart Alec that.
John I can't get into.
The search and all the rest of some of the candidates might be in this room.
<unk>.
Yeah.
My old thing about team and teamwork is pretty transparent whether it's Ben.
The sailing of a successful winter, whether it's an enterprise like Kilroy is that one of the.
The benefits you have when you have a strong team that works well together as you can talk about.
Who might be the next leader whether it be from the inside or out in good good opinions and it makes it stronger process.
And.
So more to come on that.
As regards to my continued involvement I'm chairman I am going to continue to be on the board and so forth I'm a big shareholder.
I am a big mouth, so I'll, probably talk to people who are in there probably got a few inquiries occasionally.
Asking me, whether I think this is the right thing or the wrong thing and Im open all of that.
That kind of remains to be seen.
I do believe that we've got a great management team and I think about again back to my sailing analogy.
When I was doing all my Ocean racing and I was captain the Boto is a watch captain had another watch captain always listen to what they had to say it but sometimes I overrule them.
And I would get them to come up on that kind of can tell it made them feel a little bit on energy because it's kind of our two captains on deck at the same time and you've got to trust people I think we have a really terrific team of people here that have worked really well together.
And it's the ultimate in collaboration.
So.
I am available.
But I'm pretty confident.
A lot of the decisions that get made here.
It may ultimately come down sometimes to me.
Making the final decision, but generally they're arrived that pretty quickly.
By mostly consensus.
Okay, just to clarify you're not necessarily going to stay on as chairman.
Well I'm chairman for now July at some point decided that that's not the right thing or whatever I don't know I mean, I haven't gotten there yet.
At.
Sure.
I'm going to do but is in the best interest of Kilroy.
On the rental space just wanted to ask if there was anything unique about that build out that would make it difficult to.
Lease release quickly or if something like that it's almost ready.
To move in is attractive to.
Tenants in the marketplace today.
Hi, John this is Rob.
So the Sorrento states just to frame it a little bit is in the UTC submarket and as you've heard us talk about before.
<unk> has both technology and life science and.
This project in particular was renovated.
With a life science use in mind.
We are doing some upgrades it was an existing assets. So we're doing some upgrades like the lobbies and some of the exterior and mechanical systems.
We haven't gotten control of the space yet.
But we think it's very marketable and we because we haven't started <unk> and that sort of thing we can go higher.
Other way and I think one thing I'd remind you of also is that as <unk> seen before.
Whether it's our exchange project or others.
Can play both ways. They can accommodate life science or they can accommodate tech and tech frankly loves the robust systems that life science requires.
Great. Thank you.
Okay.
Yeah.
Thank you.
And as a reminder, on behalf of the management team can we limit ourselves to one question and one follow up question.
The next question comes from the line of Caitlin Burrows of Goldman Sachs. You May proceed.
Hi, good morning.
Maybe just on pricing back in November you mentioned, an estimate of like 10%, 15% Mark to markets across the portfolio. So just wondering if you could give your latest view on that and also clarify whether that assumes flat market rents going forward.
Hey, Caitlin, it's Elliot we're between five and 10% today and if you think about the difference between then and now.
We've had rent bumps in our leases and we've signed leases that are in the <unk>.
Large part we're rolling up.
So that's where we stand today versus and we have no future growth assumed in that number thats a snapshot of where we are right now.
Okay, and then maybe separately on the dividend I mean, some peers have reduced suspended or commented that they could cut if the environment persists or weekend. So could you just comment on how you feel about kilroy current dividend coverage and under what scenario kilroy to consider modifying the dividend.
So our payout ratio is quite low.
We think our dividend is very well covered.
Obviously, we have requirements to pay out a certain portion of taxable income.
So while ultimately this is a board decision.
We're comfortable with where we are today.
Thank you. The next question comes from Michael Griffin of Citi. You May proceed.
Great. Thanks first congrats John on a great career.
Working with maybe starting on leasing under Rob.
Like leasing is down in the quarter, but second generally without they got last quarter it sounded like.
Rent spreads looked down the retention ratio a bit low I think al you talked about in the last quarter, maybe give us a sense.
What the expectations are for the remainder of the year, Rob If you could talk validated fair remarks, but any additional color around leasing activity would be helpful.
Sure.
Let me, let me touch on a few things what I would say big picture Michael.
We are in this great rebalancing right now we've gone from a very.
Employee sort of dominated market to one where it is now pushed back to the employer, meaning power leverage is back to the employer and so you see this across the board with companies, bringing their employees back to work.
That rebalance is underway and it's going to take time to settle out but in San Francisco since you were last out there.
There is a marked change once again in terms of the numbers of people downtown and Thats just by analogy in our parking garages are full so you have that going on and I would like to focus a little bit of this on San Francisco because it has been so beat up in the press.
Some of it is justified but San Francisco is still a thriving city and it has very strong attraction to young educated workers in the market right. Now there is approximately 152 tenants in the market with a total demand of about three 3 million square feet now that's down obviously.
From the high in 2019, where that might have been 8 million square feet, but I want to point that out just because.
People have a sense that everyone's sitting on the sidelines and that's that's not the case.
Of those 150 to 120 of them are active in 32 of those are pending meaning they are in.
Close to getting a lease executed.
A lot of the activity in San Francisco is generated by AI.
And I think that while AI companies have made headlines.
Think it's appreciated that the.
The majority of AI companies founded since 2020 are located in San Francisco.
And this has resulted as John said in the Bay area or San Francisco specifically.
Being home to 40% of the AI companies out there in the U S and those companies are producing the most research papers on the topic and variations of AI. So I think AI is just one segment of where innovation and creativity and what.
We're all known for in the United States in terms of entrepreneurial spirit is going to go.
In our other markets like Seattle.
I guess I'd say that other markets are going to react in different ways, meaning some will recover quicker than other San Francisco has a lot of space to clear sublease space et cetera, Seattle less so, but Seattle also has a really vibrant.
Scientific technology market and finished with this point, which.
Quite a few years Hollywood had very muted activity in terms of leasing and right now on space that we have in Hollywood, we've had more activity there more and we have more activity than we have space available and so it just shows that in a diversified geographic portfolio like Kilroy has.
Yes.
It's not all down and Thats not all up you have you have.
Just different dynamics going at any given time.
I just want to pipe in Europe , Michael and thanks for the comments, it's really a tale of two.
Cities, so to speak we've been talking about and others have talked about the differential between premier product in non premier the flight to quality and so forth last week, a bunch of us that with all our management teams.
Matter of fact, the entire offices at each region over the last six or seven days.
<unk>.
And I was just blown away from it.
In San Francisco as we reported I think it was probably the fourth quarter, a rather yes fourth quarter call that the difference between post labor day, and and pre Labor day was just extraordinary that there were so many people.
How many more people back to work the utilization rates have gone up quite a bit the traffic has gone up et cetera et cetera.
It's been another quantum jump frankly in San Francisco and Seattle in certain areas of La <unk> since that last call over the last three months that is and it literally I couldnt get into our parking structure, where our offices, we have a big parking structure there in San Francisco. The other day. It was totally full the lobby was totally pulled elevate.
<unk> were up and down people were all over the place looking at Salesforce tower next door and their lobby from where my offices as it was the same thing there the same thing over $3 50.
And you just see so many more people now we still have homeless problems. We still have client problems, we still have a bunch of other problems with those.
Chipped away at but there's some really positive things going on with people coming back to work and it's going to be I think materially I think it was another quantum jump ready to occur over the next three months or so with the big announcements like Amazon up in Seattle at some of the others in the Bay area of getting back to work now contrast that with San Diego, which.
As in most cases booming and often when we are there.
It's just on fire with people so.
Have a feeling particularly in our premier properties, where people want to be that we're going to see some material.
Improvements in this whole thing about right return to office.
I'd also say on the other side the tale of two cities. There are a lot of buildings that are just going to have problems.
San Francisco I was walking around in certain areas, where we haven't invested and it was a wholly different world in terms of much fewer people walking around garages that werent full and nobody in the lobbies and I think that's what you're going to see more and more and we've been forecasting that for some period of time.
Just a quick follow up on Seattle.
John and Rob any update on West Gate with Amazon There I think the lease expired this month.
I didn't see any news about it though anything you can comment would be helpful.
Yes.
Hey, Michael.
I don't want to comment on Amazon, specifically, but.
I think as we pointed out on either at NAREIT or different meetings we.
Literally the week of January 1st we had a group up in Seattle, John Justin Smart and others and we evaluated the West States project from a.
What do we need to do if anything to refresh it and after that meeting we've come back with.
A program that we think is really going to.
Put the project.
It's already a great location and great project, great bones, but we're going to modernize a few areas that we think are going to be really attractive to tenants we've already had.
Since we've announced the fact that we're going to be doing some renovations.
<unk> had several tours and inquiries coming up so we're very busy right now in terms of generating renderings and imagery to help sell the story of what waste West eighth will become.
And again I'll remind you it's situated in the Denny re grade, which is on the border of South Lake Union, where all the technology companies are not just Amazon. So we feel good about it.
Great and then just one follow up on on breaking the key question. We're also apologies.
Google announcements down the peninsula, San Jose the pause on the Mega campus. There any benefit may be in your mind lower I think in mountain view assets, but any benefit you could maybe have some pausing that.
Well.
I don't know, specifically it'll help kilroy and any.
Incidence I can tell you, but anytime people don't proceed with new development generally is good for existing product.
Just because it is.
It doesn't roar others or.
Or whatever so.
I know more about.
Some of these companies plans and I can share or we do.
With a major tech executive.
Yesterday and last evening for dinner and.
There definitely.
As a I think it is very healthy.
View coming out which is.
We don't need to own and everything ourselves, we don't need to develop everything all at once we really needed to demonstrate to the market that we're serious about.
Cost containment and so forth.
<unk>.
If people delay major facilities.
And it probably means the people that we're going to go and theyre going to stay somewhere else or go somewhere else.
Thank you. The next question comes from the line of Blaine Heck of Wells Fargo. Please proceed.
Great. Thanks, just a couple quick ones for me, we noticed the riot games upcoming lease expiration increased in size by about 30000 square feet can you talk about the situation there what caused that change in any color on the likelihood of renewal or move out at that space.
Yeah Blayne. This is Elliot so just on the 30000 feet nothing actually changed there. If you look at our lease expiration schedules in 2020 one.
No uptick we clarified but note last quarter, we called out the major piece of riot pleased to have a few smaller suites that are part of that we just wanted to clarify it would be a little bit more inclusive with the number.
And Blayne this is Rob in terms of right now.
Not going to be real specific but they are in space actively using it and.
It's too early.
They don't expire until November of this year so.
More to come.
Okay. That's helpful and then Elliot.
I think you talked about parking income being one of the drivers behind the strong same store results can you just talk about that a little bit more with the parking income higher than your original expectations. This quarter and how should we think about that income trending for the rest of the year.
Yes, it was both higher than our expectation and higher than than last year, and I think that that's a testament to what John said in his prepared remarks that we're just seeing better physical occupancy.
So it's our it's our hope that as that continues.
Continuing to benefit on the parking side as well.
Great. Thanks, guys.
Thank you. The next question comes from Jay <unk> of Evercore ISI. Please proceed.
Great. Thanks for taking my question I'm, just curious if you could provide a little bit of color on the Austin market and just any interest you are seeing that indeed tower I saw a little bit.
Progress this quarter in terms of what we see but any color there would be great.
Sure. This is Rob again.
As we've said before the beauty of the indeed tower that we have in the CBD is that that part of town attracts not only tech but.
Finance insurance professional.
Services firms in all of our leasing.
Other than indeed, or most of our leasing has been in those categories.
We're very pleased with the activity we have some of it's taking a little longer to get signed off on.
But.
We're going to do well.
And there are other tenants in the market there are.
As of yesterday, another big tenant popped up I'm not sure there is CBD.
But Austin continues to attract companies that are not located there and the companies that are in Austin.
I would say being cautious about taking new space with the conversations we've had indicate that.
I want to bring more people to that market. So.
I would summarize to say, we're really happy with where we are both in terms of rents lease up and what we have in the pipeline.
Flight to quality this John .
Quality thing is alive, and well and Austin as well some of the deals. We've done are people that had much lower rents in older buildings.
And they just decided it didn't work for their workforce they need to step up and we've got a bunch of that in the hopper.
But.
Every time there is a as a.
Bank crisis, or whatever people, just say well, let's go get some more authority. So some of these things have been approved by by senior management, two or three times and it just takes a while that's a little frustrating.
From our standpoint, but we've got a lot of paper, we're exchanging and.
That building is amazing and has drawn a really great crowd.
The retail or the restaurant situation there we've come to we haven't completed the documentation, but we've come to a deal with one of the best restaurant operators and their thing is like this is just amazing.
<unk> our clientele.
As I said, we were there last week last Thursday, and Friday and Austin is.
I know some other stuff I can't share with you, but I think it's solved most of its pretty much.
I think I understood. The number of companies that are looking to come to Austin right. Now is breathtaking I mean, it was breathtaking.
That's helpful. Thank you and then just one quick follow up question I think on the last call. You mentioned that indeed tower is going to be placed into the portfolio in the fourth quarter.
Remember that correctly.
That's right.
Okay. Thanks, that's all for me.
Okay.
Thank you. The next question comes from Camille now of Bank of America. Please proceed.
Curious to get your latest thoughts on the transaction marketing.
Pricing offsets.
We understand there's a lot going on in the negotiation process, but we're seeing more headlines out there.
Yes.
<unk> office anywhere from Tony.
80% down from pre pandemic levels, particularly in the west coast market.
Just given that many of these transactions are still pending.
Get your perspective on how much because you can only be reading into that.
Well this is John I made it pretty clear in my comments at the various conferences and public things that.
Around 70% as we calculated the office stock in the United States is either obsolete or soon to be obsolete and if something is trading as I haven't heard of anything trading at 80% off but.
If you've got a lousy building and nobody wants it and its vacant may not be worth anything maybe worth.
With the land value is less the demo costs and so I can't really comment without specifics in terms of the valuations being down well that's always going to have when you have interest rates go up and cap rates.
Go up and so forth. So I would say, yes values are down there is no. There is not the degree of a functioning market that we'd like to see and that wont really be there other than for high quality stuff and tell.
The interest rates sort themselves out and availability of debt and so forth sorts itself out.
Having said that.
I think that if you are on a high quality asset great location.
Whatever it is off its going to be off a lot less than if you are at the other end of the spectrum, which youre not in the right location you don't have the right quality of building or a combination of both.
A whole bunch of stuff that's come on the market that.
That are that people have tried to put on the market. We wont even look at it. It was stinker is the best of times and it's even worse today.
There have been some assets that people have wanted to trade.
I can't speak too specifically, because we signed an NDA when we looked at some of the stuff that are reasonably good assets in good markets and whatnot, but they had specific issues related to them with way too much capex or whatever and they did and they were big and they didn't get a bid that was satisfactory and pull them off the mark.
Well, that's going to happen to it in terms of.
Price discovery until there is some really some volume of transactions Camille I just think it's.
You've kind of gas.
I wouldn't read too much into it.
Other than.
Directionally if you add if it's an older building and all it doesn't necessarily mean that there's some great buildings. If you look at New York like Vornado Post office project they lease too.
Two Matt.
Classic case of an older building that fit a company's needs beautifully its fabulously improved it's a great great asset as an example, but if you happen to have an asset.
Like a lot of stuff and some of the cities that was built back to the <unk> in the seventies with lower ceiling Heights and led.
It allows the elevators and you really can improve things.
<unk> got a wasting asset and so as a problem and then we also have the issue of <unk>.
For those that have a lot of project level debt.
And they have short term.
Short terms remaining on their on their debt.
These have a problem for an example of a big building tenant youre going to put up $50 million in Capex.
And it's a good deal.
But you have two years left on your loan and if your loan was at an interest rate that's significantly lower than today's replacement loan than do you put up to $50 million you would probably say we need to renegotiate. So theres a lot of stuff that's going on older product that's going to fall.
Falling in value.
Higher interest rates, which confuse.
The debt market and so forth and then folks that have too much debt and we don't have that much data at the property level at all.
We have really good assets that are really young.
And we think we're pretty well positioned so but a lot of this stuff is going to be noisy.
I appreciate the color there.
And on a separate topic.
It was touched on earlier around the sublease space.
From a market, but could you talk about what that activity is within the portfolio and has there been any material pick up in any of your markets over the quarter.
Yes, we have Camille this is Rob we have about.
And this is available sublease space in our entire portfolio with just under $1 five square feet.
And again, what we found is that the best sublease space in any market is going quickly. So for example, 350 mission.
Last year Salesforce is sub leasing.
Both to Yelp into Sephora.
That space moved quickly and Thats, what youre going to see.
Sort of attacking off with Jon It said earlier when you look in a market like Seattle.
82% of the leasing that happened in Seattle in the quarter was a class a space while the class B space space struggled so you're just going to keep seeing that trend and that that quality sublease space will burn off quickly and then we'll be going back to more direct space. That's.
Class a in the markets over time, one of the one of the problems with sublease space.
That's not to say that these things are positive I mean, the reality is sublease space.
<unk> is a bit tricky, let's say a tenant has a.
I don't know 500000 theater I'll make it 100000 feet, making it easy 100000 square feet of direct obligation and they have a.
Three years last five years left on their lease and they have options to renew and you have a tenant comes in your sub leasing it for 20000 square feet and they want options to renew while the primary tenant sublets or is not going to say well I can give you options to renew.
Obligate themselves to exercise.
As an obligation to.
Create an obligation to exercise their own option. So depending upon the particular building not just the quality of it but the structure of the lease that the primary tenant has with the with the landlord. It can trip people up if it's ready to go space and Youre looking for something for fairly short term.
And you can get a shape that is a great deal for somebody, but it's generally more complicated than that.
Thank you for the explanation and taking my question.
Youre welcome and good day.
Thank you. The next question comes from Tayo Okusanya of Credit Suisse. Please proceed.
Hi, Yes, good morning out there let me add my congratulations on your retirement, John and I can bet, we will still be hearing much more from you going forward.
My question has to do more with my pleasure.
My question has to do with the occupancy guidance for the year.
I'm just trying to understand what's going into that number whether its just the known move outs and whether there is some type of buffer in that number for kind of anything else that may be coming and I ask that in the context of trying to understand what you'll watch list looks like today, just kind of given some of the.
Incremental challenges.
Second biotech industries right now.
Yeah, Hey, Teo Elliot so similar to what we talked about last quarter.
Occupancy guidance factors in the move outs and the move ins that.
We projected and the big ones are the ones that we've talked about earlier, but Amazon Pac 12 et cetera.
We do have some move in there.
<unk> are weighted towards the later part of the year. So as we think about the average occupancy.
So we dropped a little bit in the first quarter, we expect to drop more in the second quarter, because thats when Amazon will happen.
It gets a little bit steadier in the back half of the year, but as we think about the average that's really what's driving it and then in terms of your second question on the watch list. The majority of our watch list is still concentrated around retail tenants. Although we have seen a modest uptick in kind of our office and life science.
Tenant.
That makes up a pretty small part of the overall portfolio, though.
But is there any factoring of some of those things.
Terminating this year like again like the CRM for example, like stuff like that that need to be on the watch different ultimate will become.
Move outs.
Yes.
Like that.
No I mean, we obviously there is a range of outcomes, but we don't project watch list tenants, leaving the portfolio.
Alright, thank you.
Okay.
Thank you. The next question comes from Dylan Dubinsky as Green Street. Please proceed.
Yes.
Hi, guys. Thanks for taking the question just curious because face rents have been able to hold base rents over the last several years, but just given that availability rates across most of the markets are rising and leasing backstop.
Likely weakening do you see a scenario playing out where we actually start to see pressure on base rents in 2023.
Yes. This is John speaking I think Thats a good question.
It has to be played out for sure.
The.
Concessions.
<unk> the amount of Ti you've put up things like that so net effective rents.
Well they will deteriorate.
That's probably likely if we continue to see this thing.
Persist.
But against that backdrop. That's also a question of how much availability is there.
And so.
Having gone through this for a long time in my life.
I would always say that more availability is not generally a good thing.
Unless you are a tenant on the other hand, we have this other factor.
That has been so important which is it's all about the people of being able to attract and retain the right people and it's becoming more binary this building fits and I'll pay up for it in this building, even though it's cheap I don't want and Thats always been a factor amongst different qualities of our locations, but now.
It's become a much bigger factor with regard to just what people want for their student body.
In my prepared remarks that we want to be one of the three or four different buildings that have shown if you got 20 vacant 20 possibilities are 50 possibilities are 100 possibilities or whatever it is it a market people aren't as Rob has mentioned in prior calls you are not going to go to all those buildings youre going to 201, two or three.
And you want to you want to make sure that you've got the the presence whether it's your outside areas Youre lobby areas Youre common areas. If you have conference centers or gems or things like that you really want to present yourself well so people could see that it's a plug and play and Thats, what we do really well so.
So we really are we feel that we're going to continue to do well.
It plays out on rates I don't know.
Yes.
<unk> seen less resistance to paying higher rates.
In this last year or two than I had anticipated.
I can't tell you if that holds.
That's helpful. Thanks, and then just maybe one bigger picture one because I think on our last several conference calls you guys had mentioned AI as a potential.
Positive for San Francisco leasing activity, but I guess, just looking at what the technology will be used for right. The displacement of white collar job he'll also be viewed as a potential risk to future office demand.
Yes, I think youre right.
That takes a long time.
And I can't I'm not an expert in this area.
<unk> that are.
And some of them are extreme.
Extremely well known in this space.
And it seems to me that and again I'm not an expert I think what's going to happen is.
Back office kinds of things are going to be.
Decimated.
Anything is mostly process and not brain is going to be materially impacted that's what's going to happen first and you can get into all kinds of <unk>.
<unk> is about AI about its potential for reducing the workforce and creating a new level a higher level of what's considered full employment meeting a higher level of unemployed.
And all kinds of.
Moral discussions about it as well, which I don't want to do.
But technology the nature of Tech technology is disruptive.
You want to make money from it you figure out how to utilize it and if youre in the real estate business.
Out how are you.
Present yourself is a property of choice.
How big it's going to be I don't know, but everything I hear is it's going to be huge.
It's so early how do you know.
Dylan. This is Elliott one thing that I'd add to that is when you look at a lot of the innovation that has come from places like the Bay area.
You could argue that some of that should have displaced jobs white collar jobs as well and what in turn what often winds up happening is it just makes it more efficient for people and allows them to innovate in different ways right and so if you think about AI, helping somebody code or an engineer right that engineered can be a lot more.
And now the realm.
The options or possibilities that they can innovate has grown exponentially that allows for a greater multiplier effect. So it could actually really go the other way where it helps more innovation more company growth et cetera, well that's exactly what's happened over the last 20 years. All of these technologies that came along that we're going to put everybody out of work and so forth actually want.
The other way and they become the game the biggest consumers of space right and the biggest hires.
If I knew the answer to that question not be investing in a different area.
No I appreciate the color that's very helpful. Thanks, guys.
Thank you there are currently no additional questions registered at this time, so I will pass the conference back over to Mitch Mr. Hutchison for any closing remarks.
Daniel Thank you for your assistance today and thank you everyone for joining US. We appreciate your continued interest in kilroy.
And with that we will conclude today's conference call. Thank you for participating you may now disconnect your lines.
Okay.