Kilroy Realty Corporation (KRC) Earnings Call Transcript & Summary

My name is Camille Bonnel. I'm the office and Industrial U.S. REIT analyst here at Bank of America. And I'm joined by my colleague, [indiscernible]. Today's roundtable session is now with Kilroy. And we have a great representation from management, John in the middle, Chairman and CEO. We're also joined by Justin Smart, President; Eliott Trencher, Chief Financial Officer and Chief Investment Officer; Rob Paratte, EVP of Business Development; and Bill Hutcheson, IR. It won't be the last time we see you. But John, we appreciate you participating for a final time at our conference. And I don't think this will be a final goodbye since I believe you plan to stay on as Chairman. Any thoughts you'd like to kick off the meeting with?

Well, I've been doing this a long time, and I'm looking around, I see a few other people with gray hair and some of them didn't have gray hair when I first met them. I'm going to be doing my 54th NAREIT conference in November. And if somebody had told me that I was going to do that, way back when, I would have said, you're out of your mind. I do think there is some kind of conspiracy because there must be some unwritten rule that if you're in the REIT industry, you've got to stay at hotels or go to these hotels that are not exactly terrific, but this one is okay. Thank you for having us here, and let's get going.

All right. I guess on that note, any update you can provide, on the succession planning and key qualities that you're looking for in the next CEO?

I'm not going to get into that in detail because that's a Board issue, and we're actively underway now with our search. And we have some initial rounds of folks that we're talking with, both internally and externally. And our intent is to try to get this done by the end of the year. We want to make sure we get the right person in the spot, and that's about all I can tell you at this point.

All right. And we'd like to make this an interactive discussion. So if anyone has a question behind me, feel free to ask. But given where it today is, sentiment is very negative on the sector, but I think there is a view that we might be nearing a bottom or at least the deceleration is slowing. I'd like to get your thoughts on how you characterize where we are in the office sector? And what's [ go there ].

Well, there obviously -- there are a number of influences that many of us have been aware of and talked about at length over the course of the last couple of years that are influencing the office sector. And I'm not going to list it in order of priority, but let me give you a few things. It's very much on our mind. One is, we've been, I think, the leaders in providing modern workplace environments to our tenants and prospective tenants over the course of the last several years. And I think we identified earlier than most that there's been a seismic change in the way people are using office space in a kind of space they want. There's roughly 70% of the office space in this country that's either obsolete or growing obsolete, and that's not the asset you want to own as a stock investor in an office company or as a direct investor of an office building or as a lender to an office company, and it's not where you want to be if you're a tenant. So there has been a seismic change in the way people are thinking about product. We've seen sustainability become a big issue over the years. We've been the leader in that for 10 years. We've seen wellness become a bigger and bigger issue with tenants. We've been the leader in that. I think we own more well buildings than anybody in the United States other than the United States government. So I think we've made the right calculations and investments in the type of assets. The other thing that's been very much, on people's mind, is return-to-office or RTO. We're seeing that in full bloom right now. People -- office is very relevant, but it's the kind of office space that people want, not the obsolete stuff. We're seeing a real flight to quality. That's been going on for some period of time. The pandemic, of course, accelerated that. I think we're very well positioned in both our core portfolio and our development pipeline to provide state-of-the-art product. The other thing that's happened, of course, is we're in a -- we've had a pandemic. And that increased -- that, of course, caused people to not come to work. And as I mentioned, RTO is back in full force. But what's really important is that more and more companies have thrown down the edict that you will be back in the office. It could be 2 days a week. It could be 5 days a week, but you'll be back in the office. If you noticed, Zoom came out with an edict that you're coming back to the office because they need to have the collaboration and the teamwork and so forth to develop innovative products as well. And I thought that was a really great proxy. So we're seeing that, and we're seeing utilization rates increase very substantially. It's different in each market. We're seeing the type of product and amenities that people want. We're doing well in our products with regard to that, and there's been a seismic shift there as well. So those are big influencers. And then, of course, we have this little thing, are we in a recession? Are we not in a recession? And obviously, there's been interruptors with regard to interest rates and availability of debt and so forth. And I think that you're going to see a couple of these factors play out probably along the following lines. Obsolete buildings are not going to attract lenders because lenders don't want to lend obsolete buildings. There are a number of buildings, be it the obsolete or not obsolete, that have feasted on low-cost debt. And think about the dilemma you have as an owner. You'd say you've just done a lease, you're doing a lease with a tenant, and it requires $10 million, $20 million, $50 million of improvements and so forth, tenant improvement work, et cetera, and you have a loan coming due in a couple of years. And you know that's an irreplaceable loan because the interest rate that you have is not achievable again. So now the question is, do you go ahead and do that deal and invest that money? Or do you say, I got to wait until I work out something with my lender. So I think there's going to be a number of buildings and owners in the country that are going to have a difficult time leasing their buildings and funding that. So those things tend to play well, I think, for us. But notwithstanding that, we're in the office business as well as life science and some resi and retail, and those negative influences are going to impact everybody. From our standpoint, balance sheet-wise, I think we have the best-in-class balance sheet. We have $2 billion worth of liquidity. We've just done some interesting things that Eliott can talk about. And we've got a great tenant profile. 50% of our tenants are high grade-rated, and we're very confident in that. We have a great schedule on lease terminations and loan terminations and so forth. So as a company, I don't think we've ever been in better shape in a recession than we are today.

Can you expand a little bit more on those utilization rates that you're seeing within the portfolio? Because when we look at public card data, San Fran continues to lag, and it seems like it's driven by the tech industry. But when you hear about the footfall activity going in -- on in Manhattan, it just seems like they're polar opposite. So what are you seeing within [indiscernible]?

Sure, Camille. Good afternoon, everyone. I think one of the misleading things I'll pick on Kastle data since everybody refers to Kastle. One of the big misleading factors in that data is that they're only tracking card key and a lot of buildings in the country do not have card key access. You have a security desk, you check in and you go upstairs. So you're missing a lot of suburban activity. You're also missing a lot of activity, particularly on the West Coast, where security is not as stringent as it is here in Manhattan. The other thing I'd say is that it's -- in general, using Kastle as well as our own data that we provide or that we access on our buildings and our tenants, is that occupancy has gone up quite dramatically. And it really took hold probably in, I would say, May 1 of this year when Amazon was the first to really put meat into the concept that you're coming back to work, and it's not when it's convenient for you. Subsequent to Amazon doing that, many other companies, including Zoom, as John mentioned, have followed. So you do see much more foot traffic in a city like San Francisco. For example, I've been impressed when I've come to Manhattan the last year or so with the number of people that are back. San Francisco is getting there, and so is Seattle. And keep in mind, those two cities were the longest -- with the longest, most prolonged pandemic shutdowns, so they are catching up, but they're doing actually quite well. Our parking revenue is up. We often have our parking garages full by midmorning, which we haven't seen for a while. The last thing I'd say about occupancy that all of us need to keep in mind, or I guess, particularly when you talk about Kilroy, is that we build high-performance buildings. We own high-performance buildings. That's what these growth tenants want. They're hiring knowledge workers and they're hiring people that are professionals. And so even before the pandemic, you had a maximum physical occupancy somewhere in the 60% to 70% range. And if you look at it today with some of the companies we've talked to, they're saying, whether it's 2 or 3 days a week or 4 days a week or whatever the number of days a week people are in the office, 50% of that time is in the office, but other parts of that time are in customer offices or off-sites and other sorts of venues that you were doing prior to 2019. So I think it's a misnomer to really look at data that we're going to get to 100% occupancy. Maybe call centers were like that, but professional services were not.

And we heard from one of the panels this morning, there seems like there's improving CBD trends, and particularly around Seattle, which is a bit of an outlier look across the West markets. So what are you specifically seeing in that market? Is it driven by Amazon's RTO?

Again, Amazon is the largest employer in that market in the Pacific Northwest. So yes, they do drive a lot. But there are other tenants in the market. It has a -- Seattle does have a life science component to it. And there's also an AI component that has been growing in Seattle as in San Francisco. So I think the best thing that happened in the Pacific Northwest over the last 10 years is the broad diversity that's come to the market, not only Amazon, but Apple, Facebook, Google, Salesforce, you name it. They have a terrific talent base there for tech, but they also have a good strong fire category segment to the market.

[indiscernible] political situation out in L.A. and San Francisco and now that's been a challenge to getting back to work. How is that going? How do you see it today? Anything changed?

Mark, I thought somebody might ask that question. So I want to give you San Francisco because that's one people seem to focus on the most. And it's different in each city. I would characterize the issues of homelessness, crime, drug dealing, all these things that we've seen impact negatively so many American cities, probably elsewhere in the world. It's a scourge. You can't have society function and business function with that kind of activity going on prolifically. You'll never get rid of all of it. So what's happened in San Francisco? I mentioned over the course of the last couple of years that a bunch of us have gotten together to form a broad coalition, and it's not just real estate, it's across all industries. It's across all kinds of homeowners, all demographics. People are fed up with it. And they're fed up within San Francisco and they're fed up with it elsewhere. So what do we do? We changed some of the school board members through our group. Then we got rid of the district attorney, Chesa Boudin and we got in Jenkins. And Jenkins, she's a tough prosecutor. She's hard on crime. Then we got her reelected. So the crack down on drug dealing and use in San Francisco is underway big time. I'm going to give you a couple of little statistics or comments here. You have a task force that consists of the DEA, I believe, the FBI, the state of California and its various agencies, including the CHP, et cetera. You have the Sheriff's department, you have, San Francisco PD, all cracking down on crime. They've arrested over 300 violent drug dealers this year. They're prosecuting them. Persecuting is probably a good idea, too. But they're prosecuting them. And then what we're doing is we're going after the judges. That we're going to expose the judges. I don't know whether all of you vote, but there's always this thing, "What judges do you vote for?" Well, you can get their records. So now what we're doing is a coalition called Neighbors is exposing the judges that are soft on crime. They just -- they refused to handout sentences. And all of those things are part of an effort, and an effort that's very important to accomplish, to clean up this illegal activity. It's been prolific. The snatch and grab stuff you heard about all over California. You heard about it in other cities as well. It just can't go on. There is an effort right now to change next year, in the '24 election, a number of the Board of Supervisors. Our group was able to get two moderates -- two additional moderates in the '22 election. I think we'll get 2 maybe 3 in the '24 election. If we do that, we'll have a majority on the Board of Supervisors. For those who don't know, San Francisco is a city, county government, California. We have city councils, and we have county Board supervisors. So they're one and the same when I talk about the supervisors in San Francisco. I'm not going to talk about some of the other candidates because it's probably inappropriate to do so. And occasionally, I don't violate that. But I will tell you, this is serious and there is big money, big interest, broad cross-section in this coalition. The increase in police funding, it's at an all-time high. They're the highest paid police officers, I think in California, certainly in the Bay Area. We're hiring 220 new police officers. We probably need a couple of hundred more, but there's a big increase in police funding. The crime trends are really starting to tick down and be favorable. That doesn't mean they're acceptable, but they are more favorable. And on business taxes. The city of San Francisco recently approved an annual budget, which pauses a bunch of scheduled tax increases and that included new tax incentives for downtown businesses. And I think that trend is likely to continue. [ Said in Kilroy ] speak, we had an unacceptable group of people for a long time with very bad policy and not causing people to adhere to the law. You cannot have a decent society and have that happen, and that's being rolled back now. It's not going to be easy. It's going to be a continuous fight, but there are a lot of people in it. And now as people are coming back and occupying your buildings, I think you'll see a lot of the big office users put added pressure on the city and its various agencies to clean things up. So I'm more optimistic about the city of San Francisco than I've been in the last 2 years. That does not mean it's fixed, it's the beginning of being fixed. But like I've said before, a train that's going the wrong way has to stop before it has a chance to go back the correct way. And I think that's where we're at. L.A. has its own set of issues, but similar things are happening. Seattle has had a bunch of issues. They replaced the mayor and a bunch of people that were not constructive on the City Council. They brought in a new district attorney. This was a couple of years ago. They're making real strides there. It's a little bit weird to be sitting in a business conference like this, at this stage of my career, and I'm wondering what the heck happened to common decency, the enforcement laws? And how do we ever tolerate this stuff? And I would just encourage every one of you, if you see this in your communities, stand up and fight because you can make a difference, and it's happening. So that's what's happened -- that's the big top-down summary.

And so you touched on how Kilroy has curated a portfolio that remains relevant in this new way of working. Can you just expand on how you define quality? And what you're hearing from tenants on their space requirements?

Well, let's talk about what the want to work workplace environment is. It's highly efficient buildings. They're generally higher Florida height. They have bigger floor place. They have higher density of restrooms, better mechanicals. They're sustainable. They're well. They have a lot of people areas inside and out. They're surrounded by tremendous number of amenities, either within the [indiscernible] in which they sit or within the community in which they sit. They have all the bells and whistles that people want. And if you don't have those things, you've got a real problem. You've got something that's heading to or is already obsolete. So basically, if a tenant is on tour, and they've got 50 opportunities or 20 opportunities and spaces are big enough for them, they're not going to go to 50 or 30 places, they're going to go to 5 or 3. And we're always going to be at 1 of the 3 or 5, and that's our goal. And then our space is market-ready, speed to market. So what happens in these downturns? And this one's different because of pandemic and so forth and the obsolescence issues that are confronting our industry. But what always happens is things look so dark and then, bang, all of a sudden, you see some deals being done and then some more done. So I go back to 20 -- 2000, the big tech bust, right? So what happened? People said in '21 that there was 20-plus years of supply in Silicon Valley. And within 2 years, it was like 2% or 3% vacancy. I think that was 2020. So basically, space gets absorbed very quickly when it's a growth market in our particular markets, it's -- there is a contraction for sure that's going on. And part of that is because of the economy and part of it is because some of the tech companies have decided not to pursue various products they were thinking about developing. And part of it is simply because they didn't know what space they were going to need because everybody was working from home. Now that's changing. And I think you'll see -- I'm not going to predict whether it's all this year, but let's just say within the next year or so, I think you're going to see a far different situation in our markets than you see today.

And on that topic of AI, technology, growth, have you guys tried to quantify the opportunity within your portfolio in markets?

Well, we're in the markets where AI is located. I mean I can't name the tenant because I'm not supposed to use their name. This is just being recorded, right? So we did a major AI facility. It's a global AI facility in Seattle for a big tech user, and that's growing up there. Most of San Francisco -- you can talk, if you will, Rob, too.

Sure. So everyone is talking about AI, and there's a reason for it. Because if you look at San Francisco, right now, we have about 3.9 million square feet of demand in the office sector. About 35% of that is technology, and somewhere around 20% to 25% of that is related to AI. Camille, we have AI tenants in our buildings now and have had, and some of them are -- all of them actually are very good credit. I think a couple of things to think about with San Francisco and AI, the bulk of national funding, VC funding for AI is going to the city of San Francisco, not the Bay Area, although the Bay Area is a leader. Nationally, the bulk of the funding is going to San Francisco. Since 2018, there's been $120 billion of VC funding directed to AI in the Bay Area. So it is the center of where everything is going on. Average deal size for AI tenants started out pretty small. It's now averaging around 14,000 feet. There was recently about 150,000-foot AI deal done in the market, and one of our tenants and one of our buildings sublet space to an AI company as well. So it's definitely in the market and creating demand. But the thing that's been really helpful to San Francisco during this downturn is that the fire category tenants, banks, finance, insurance companies have also been moving to quality space and absorbing space, taking advantage of opportunities when they see it.

Can we also touch on the life science and supply outlook [ you're seeing ] in your market?

Sure. So probably about -- 2 years ago, demand in -- and I'll talk about specifically South San Francisco because that is the dominant life science market on the West Coast. We had about 3.5 million square feet of demand -- 3 million to 3.5 million square feet of demand. Today, that's about 1.5 million. The delta between that 1.5 million of demand today and what was is still out there. It's on hold. A lot of boards or companies, whether they were venture-backed or late-stage, basically said to their companies, despite the fact that you're hiring people, let's put the brakes on taking down space. And we have had some conversations with people that lead us to believe that some of that may get relaxed. We still continue on the West Coast to outpace other markets from a funding point of view -- on a VC funding point of view in South San Francisco, and that's a positive. There's some sublease space on the market, to be frank. It's about 800,000 feet. Some of it's okay space, not great. Some of it's quite good, and the quite good space will move quickly. Because one of the things about sublease space that helps the company when it's hard to have clarity is that it provides flexibility until you can really make a decision. So we have 3 buildings under construction. Skin is on the buildings. They are in terrific shape right now. We're right on San Francisco Bay. 1 of the 3, we've multi-tenanted, and we'll be delivering spec labs to the market, and that's really broadened the net, so to speak, of companies and activity that we've been talking to.

We do have a few more questions on operations, but I do want to give Eliott a chance to speak just around the balance sheet management. Can you talk about the philosophy of Kilroy and decision behind addressing 2024 maturities so far in advance?

Yes, sure. So as many of you probably know, we raised $375 million earlier this year via secured debt on our One Paseo project in San Diego. And the thought behind it was we really like the optionality that it provided us to both on an offensive perspective and a defensive perspective. And without knowing exactly how the economy will play out over the next year or 2, if things are challenging, then defensively, we have enough cash on our balance sheet today to fund our 2024 bond maturity, which is in December, development for this year and most of next year. So we can really hunker down. If things get tough, we've got cash. It will -- and we have a line. We have a $1.1 billion line that would remain totally untapped. So it gives us a lot of flexibility in a defensive scenario. If things are better, then we now have $375 million more of cash to go on offense. So that flexibility is very valuable to us. We were able to get a 5.9% interest rate with an 11-year tenure, which, in the scheme of things, is we think is a pretty good piece of paper to hold over that period of time. It keeps our debt maturity pretty staggered. And the cost of doing that early was pretty modest, given where interest rates are today. So we can invest that cash at a pretty attractive rate, minimize any sort of near-term earnings dilution and keep that longer-term optionality.

And are you starting to see more of those investment opportunities to come to market?

So for us, we really haven't seen a ton yet. There are a few things kind of around the margin that we're looking at, but nothing of size or scale. Most of what we've seen trade has been much lower quality product. It's not the kind of product that we want to own over the long run. And so we keep our finger on the pulse of what's going on. We -- you can look at our track record and see how we have been acquisitive at certain times in various cycles. So we're ready to do it if the opportunities are there, but we're not quite seeing them just yet.

What we are seeing is there are a number of folks that have come to us about recapping. In some cases, as buildings and cases that -- I'm sorry, but I happen to be sitting on a very uneven part of the floor here, and I have a table thing in front of me, so I'm trying to get comfortable. There are a number of developers that have worked for a number of years to [ ton of ] projects where they have a capital partner that is no longer interested or they're unable to achieve the kind of financing they'd like to achieve. So I think there's going to be some opportunities in a variety of different areas. But if you think about it, if we and the brokerage community is right, then 70% of the product in the country is obsolete. Don't want to buy that. Only want to buy good stuff. And most of the good stuff is owned by pretty good institutional owners. So in some cases, it's owned by maybe some private folks where they have an ownership consortium that may not be working well together. They may not be able to get debt replacement and so forth. So there's going to be some opportunities there. But as Eliott mentioned, we haven't seen anything in scale that we like. We're seeing a couple of little things that are adjacent to some properties we have that we think we could acquire attractively and create some value. But we're not there yet, by offense. But I would remind everybody, in 2008, in San Diego at NAREIT, every investor, and I think every management team was talking about, will there be a real estate industry? Will there be financing? Look at some of our friends down at the end of the table, they nod -- they're nodding their head, they remember. What we said in [ 2009 ] in Arizona, NAREIT, the fall NAREIT, is you will see us in San Francisco, Seattle, Portland, any number of cities looking around so that when we feels the time to strike, we'll be there. And we will have done our homework. And in 2010 in May, we were selected by 303 Second Street. And the locals couldn't believe it. Who were these guys? And the locals were all focused on their problems. The most important thing in a time like this, in this -- I'll use a kind of an analogy that many of you heard -- have heard, there's a reason why the windshield is a lot bigger than the rearview mirror. The rearview mirror is the past, the windshield is what's out there and opportunistically where you can play the game. If you are so confronted with problems that you can't think about opportunities, or if you're so constrained in your balance sheet that you can't fund opportunities, then you're not going to come out of this thing nearly as well. We've come out every cycle better, and we've never been positioned more attractively than we are in this one. So I'm sort of optimistic for the next couple of years. I think there's going to be some great opportunities. But I don't think it's buying big portfolio.

We have time for probably one or two more questions before the rapid fire. I think [indiscernible]. Anyone has questions?

Yes maybe [indiscernible] on my end, curious your thoughts on now [indiscernible]?

I guess I would counter your question with, we, at least in our portfolio, have not seen negative effective -- net effective rents drop significantly. I mean here and there, you might be off 5% from where you were. But frankly, from the pandemic and throughout the pandemic, net effective rents and the best quality buildings actually increased and surpassed the increase in tenant improvement costs, and that's particularly true in the field of life science. If you have a product that is not well located, everything that John was hitting on. If you're not well located, you don't have amenities, you don't have light and air, clear heights, elevators that are able to handle the density, you're just not even going to make the tour list. So in San Francisco, for example, if you need 50,000 feet, you have over 150 choices. No one is going to take the time or have the time to tour that many spaces. So you've got to get down to that list of five. And list of five, when you really look at the vacancy rate in San Francisco, the higher-quality buildings, premium tier that we operate in is half of what the overall market vacancy rate is. So again, stating it another way, if you've got inferior product, your net effective rents, maybe you're covering your operating expenses. But with superior product, what I call high-performance premium product, I'd say net effective rents in San Francisco are stable. And in some of our other markets, they've actually increased.

Before we get to the rapid fire, just one point we wanted to make, which we've brought up in some of our individual meetings is when we look -- we talked about our balance sheet and some of the offensive and defensive optionality. In addition to having pretty low leverage and be investment-grade rated, we generate free cash flow -- pretty meaningful free cash flow. We also have a low 60% FAD payout ratio. So when we look at ourselves and compare ourselves to some of our peers, our payout ratio is about 15 percentage points lower. This is after increasing our dividend 55% since 2016. So we have a pretty secure and stable dividend that we think is another attractive thing about the company. And then for those listening on the webcast, we did also publish some slides that are on our website for anyone that wants to look at them.

That's perfect. I was going to put in a question on the dividend, but obliged you covered it. So we can go into our rapid fire. Sorry. There's one more question.

[indiscernible] offense. What sort of valuation declines [indiscernible]?

I don't want to get too specific on that because it's going to be different in every market. I think the way we look at it is we operate in our company by three kind of really simplistic sort of objects, if you will. One is a circle. It's got to be where you want to be, where the business want to be, has the amenities and so forth. One is the square, which represents physicality, are the buildings kind of buildings that people really want to be in. And then there's a triangle. And the triangle simply means, is it time? And can you make money? If it doesn't, give a yes -- a resounding yes, in each of those three shapes of those conditions. We're not interested in buying it or developing it. I think that the big problem with answering that question is there are things that are trading at cap rates that are fairly high at -- if it would have traded at the 1,000, it's trading at 800, but the rents are probably overmarket and the billings aren't that great. And when a tenant moves out, you got $200 or $300, $400 worth of stuff to do. So you look at it and say, unless I've got a really terrific asset, that's as good as new, why don't I want that asset? If it's not terrific, and I've got this big CapEx thing downstream. So it may look attractive on a price per pound basis. It may look attractive on a cap rate basis, but at the end of the day, when you reposition it, you take the risk til you get the kind of yield you want to have and is it the kind of asset, you want to own for the long term. That's why it has such a [indiscernible] over that. It's very asset and location-specific.

Okay. Just on the rapid fire questions. The first one is on the Fed. Do you believe the Fed is done hiking? Yes or no?

No.

And do you expect the Feds [ to cut ] in '24? Yes or no?

No.

Second, do you believe real estate transactions will meaningfully pick up by a, the fourth quarter of '23; b, the first half of '24; or c, the second half '24?

I'm kind of thinking you're going to be somewhere between the mid and the end of next year. But remember, we've got an election coming up. And there's crazy things going to happen in election years, too.

To generate more activity?

Well, they could influence the financial markets is what I'm saying. It depends. If there's a particular candidate that -- and I don't know what they're going to be, I wish I could define that, but I can't. That could influence substantially the markets. But I think you're going to see -- there is -- there will be a new normal. I'm not sure exactly what it will be, but I will say this, in my career, I've never seen anything with 3% or even 4% interest rates until 2010. Never in my life, and I'm 74. I've been in those for 54 years. So the interest rates, where they are today is pretty much kind of like most of my career. I made money in -- with interest rates -- when the prime, what was it? Up to 17% or 18%? It actually went up to 20% at one point.

[indiscernible].

Pardon me.

10-year [indiscernible].

Yes, and I remember doing some of the best deals that I've ever done then. And it was crazy to say that. But the market will figure out a way to work and people that are running new product. If there isn't new product around, they're going to have to have it built and they're going to pay for them. So just remember this, people costs are around 80% to 85% of most companies' cost structure, and real estate is roughly 5%. So if real state costs 6% or 7%, it doesn't matter really if it influences positively the 80%. We're all math people in this. I don't -- I think everybody would agree, that's positive leverage. So we're going to see a normal that will work. And if you don't have the product, the people, the balance sheet, you're not going to be able to play. And I think that's what really differentiates Kilroy. We're really well positioned.

And finally, last question, 2-part question. Are you using AI today to help run your business? Yes or no?

No.

And do you plan to ramp up spending on AI initiatives?

I'm sure we will. It's early. I heard the other day that there's somebody is thinking about replacing air traffic control with AI. I'm going to ride my bicycle.

All right. Thank you.

Thank you, Camille. Thanks, everybody, for attending.