Kilroy Realty Corporation (KRC) Earnings Call Transcript & Summary

I think we're going to get started with the Kilroy Realty roundtable session. My name is Camille Bonnel. I am the office analyst here at Bank of America. And I'm joined today by -- I'm not sure how many people have met this team -- management team yet, but we have here in the center, CEO, Angela Aman. Next to her is CFO, who just started just a few weeks ago, Jeffrey Kuehling, thank you. And many of you will know Eliott Trencher, who has recently moved into a CIO role and at leasing, Robert Paratte. We've just -- I think before we actually get into the discussion, it would be great, Angela or Jeffrey for a quick introduction given it hasn't even been a few weeks for Jeffrey, so...

Yes, sure. My name is Angela. I started with the company back at the end of January of this year. I've been a CFO at a number of different publicly traded real estate platforms for the last 12 years, I think. So I'm familiar with a lot of people in the room, they're not everybody on the office side. It's been a great transition into the company. This entire team and really the entire platform is -- has been incredibly helpful in working with me to get up to speed quickly, to understanding the challenges and opportunities across this platform. And everybody was really ready and willing to dive in as soon as I joined. So looking forward to meeting all of you if we haven't met yet. Jeffrey and I have worked together a couple of different times in our past lives. We made the decision, as Camille was mentioning and got announced on the last earnings call to split what had been a very big role for Eliott in both the Chief Investment Officer and Chief Financial Officer responsibilities, just with the acknowledgment that especially as the transaction market continues to open up and thought across our markets that both of these functions are going to be incredibly busy over the next couple of years, and to just make sure that we've got the right resources focused on the right things. So I'm very excited to bring Jeffrey over, and I think he's been working really well with the entire team over the last few weeks, both on the finance and accounting side, on the data and technology side, but also in leasing, operations, development, really the entire platform. Anything you want to add?

No, that was great, thanks.

And it's pretty insane how quickly time is passing. It's already 9 months where you, Angela you are here on the team. I was just wondering if you could give us some insights into how your key priorities are shaping up?

Yes. I think the first sort of, I don't know, 4 to 6 weeks, I was really just focused on getting out and seeing really the entire portfolio as quickly as I could to meeting the region team, so we have managing each of these portfolios in those locations. And just understanding, like I mentioned earlier, both the challenges and opportunities that are embedded in this portfolio. For those of you who might be less familiar with Kilroy, we're really concentrated in 5 major markets on the West Coast and then in Austin, Texas. And that portfolio layout gives you the opportunity to really go deep and understand the markets that we're operating in, and to really have teams that are super focused and embedded in those markets and understand all the players. And so spending time to just get my arms around that was the first and foremost priority. From there, really just spending a lot of time over the following couple of months to make sure that every function in the company was resourced appropriately, that we had all of the right attention and all the right areas that when we think about sort of our bigger picture goals, particularly on the leasing side that we had all of the -- we were enabling our leasing teams with all of the tools that might be necessary to do or what we're asking them to do in a very challenging environment, which is capture an outsized amount of market share from the leases that are happening in some challenging markets like Los Angeles, like San Francisco, some other places. So that focus and the conversations I had with everybody across the platform to make sure we were all aligned on what some of those big picture goals were, but to really hear from people about what they thought would put them in a position to make sure they can do that was incredibly important to me. And there are all kinds of changes we made in those first few months that might not be perfectly visible externally, but I think are really important along those lines, just in terms of making sure that we are positioned to really capture market share and participate as fully in the recovery that we do see happening in all of our markets as possible. And some of those changes included making sure we bring on additional senior leasing resources like we recently announced in San Francisco. We reconstituted a Leasing Marketing department under Rob as well. They've been something the company had historically. But over the last several years, had sort of phase that out and move to more of an outsourced kind of broker focused model on marketing our spaces and making sure the team had resources there. A number of different things like that kind of tweaks to the platform just to make sure that we're appropriately positioned. From there, stepping back to think about capital allocation and what do we have available in terms of challenges and opportunities in the portfolio, where are we really headed? Where do we have capital tied up in assets, where we are or can expect to earn a return that's below our cost of capital, and that led to one of the key focus points early on being really a reevaluation and thorough review of our future land pipeline, future development pipeline and understanding each of those parcels and walking through in an effort that Eliott really led, walking through each of those parcels to understand the investment thesis when we acquired those parcels and how that's changed in each of the markets and what the highest and best use now is. And as we mentioned also in the last call, we've made determinations on several of those parcels at the highest and best use is probably something at this point that's outside of our core competency as a office in life science development. And as a result, we think probably monetization of at least to those -- a few of those parcels is going to make the most sense. We did say as part of that communication that in our evaluation and talking to market participants, it's going to make sense for us -- in most cases, to hold those parcels through a reentitlement phase in order to maximize value for shareholders. So while it's going to take time in order to be able to pull some proceeds back to the company in that exercise, just the underlying fact that we have capital tied up in nonincome-producing assets today where there is a healthy and active market for those assets, and we'll be able to monetize that capital and redeploy it into a transaction market in our core asset classes, that is continuing to thaw and we think we'll be very active, and there will be some interesting opportunities over the next couple of years is really important in terms of how we go forward as well. So I think that kind of covers it. It's been portfolio, it's been platform, it's been processes in number of situations, just making sure across every facet of this business, we're positioned appropriately and ready to execute.

And I appreciate culture doesn't change overnight. And what we see on our end is updated -- disclosures, which have been very helpful. So just building on those points, just curious how long is it going to take to get you to where you want to be? And does the size and resourcing today after the changes you have made? Are they appropriate? Or is there still more work?

There's some additional platform things we're working on that just won't be as visible to the investment community, but certain different functions within the company, I want to make sure we've got the right senior leadership looking at, but nothing that would really come high up on investors' list of focus. So there are additional changes. I don't know that it's -- I don't think about it having been on the corporate side for as long as I have. I don't know that I think about it exactly like when will you get to the finish line. I think if you're a dynamic platform and you're responding to changes in the market, changes in the environment and changes in technology and changes in all of these things, you're constantly sort of tweaking parts of the platform to make sure that you're as efficient as you can be and that you're as forward-looking and data-driven as you can be. And those things never really stops. So I'm not thinking about it in terms of an endpoint as much as I am just making sure that we're continuing to progress in the right direction. And importantly, that we're just putting ourselves in a position, as I said to the team last week at an off-site that we did, just putting us in a position to make the next right decision on everything that we're tackling. And whether it's leasing, whether it's development, whether it's a land bank, whether it's acquisitions, whether it's balance sheet, let's just make sure we're in a position to continue making the next best decision.

One last question on this topic and feel free to ask any questions if you're in the audience, but I'm curious, Angela, what perspectives are you hoping to bring in this new role. Any similarities at a fundamental level from your prior experience at Brixmor? How do you think you can leverage?

I mean there are certain things about -- I think the perspective of a different asset class can be helpful in certain situations just in terms of [indiscernible] through. As I mentioned in my first earnings call, which was, I think, 10 or 11 days into my time at Kilroy, thinking through issues that are facing the office sector right now in particular like functional obsolescence. And I think whether it was my time at Brixmor or before that time I spend in other parts of the retail universe, there are some valuable lessons, I think, to bring from all of that. But I would also just say my perspective from having been on really 3 different platforms on the corporate side, and one thing I'm very much hoping to bring to Kilroy, it's just an understanding that most real estate companies, and certainly, at Kilroy, we might be big from an asset value perspective, but we're pretty small from a people perspective, and that means we can be pretty nimble. And so trying to make sure we create a culture internally where people understand that if there are real pain points, there are real things that are slowing us down or are making it more difficult for our teams to execute, whether it's on the leasing side or development or transactions or whatever it is, that we can fix them. I think people embedded in companies, especially people with long tenures at companies sometimes can forget that. You fall into patterns and people forget to raise their hand and say this thing over here is like a little bit broken and we'd love to fix this and just trying to create a culture of, let's fix it, right? Let's make every part of the -- lets care about every part of the platform, and let's make sure every part of the platform is working as efficiently as it can.

And I'll open this question up to the panel. On that point around functional obsolescence, it seems like that definition of quality continues to evolve. So I'm curious, as you look at investments, maybe from an investment perspective, what do you define as quality today?

Do you want to start?

Yes, sure. It's not a black and white definition. And I think that when we look at a building, whether it's a building that we are looking to acquire or whether it's a building that we already own in the portfolio, we're evaluating a few different characteristics. I mean, one, what kind of market are you in? And that matters not at the market level, but also at the submarket level. There are some markets that just have really strong demand drivers such that you don't need to have a new and shiny building to attract tenants and tenants that want to pay high rent, you can have proximity to things like transportation, proximity to an amenity base, proximity to other major companies, all of which drive a lot of value, and that's pretty important. I think physically, there are things like when the building was built, what are the size of the floor plates? How much open spacing is there? What's the natural air and what's the light like, how much outdoor space is there? What are the amenities, is their rooftop access, what are the views. There are so many different components to determining quality, and depending on what market it's in and what dynamics there are, everyone is going to weigh those things differently. So we don't go in thinking that there's a prescriptive answer, but we do look at a whole host of things when determining quality, and then obviously, there's a component of value and how we see value to all of these different elements.

If you would rank, like if you were to rank 1 or 2 markets that are on your radar in terms of this thesis you're building, what would they be?

Well, I mean, I would just say we're going to continue to be active really in all of our markets, right? Austin is a market in particular, where, as everybody knows, I think the company made an entry into Austin a couple of years ago. We've got 1 very high-quality building in the Austin market, and we do want to continue to grow that portfolio. And I think all the points Eliott made in terms of how we assess and think about quality and the breadth and depth of tenant demand in markets and things like that, that's clearly a market where I think there will be opportunity for us to continue to grow our presence and to continue to do it in the kind of quality assets that Eliott just described.

Yes. No, I agree with that, and I was going to say, we like the 5 markets that we're in. We see a lot of opportunity in each of those markets. And so we would expect that any growth that happens is in 1 of those 5.

And is the opportunity set more through acquisitions today, debt loans, like, I guess, how would you rank building that exposure?

Yes. I think that -- I mean, historically, we've been the kind of group that has acquired when it made sense and developed when it made sense. We haven't gone through other parts of the capital stack, but we're open to that. Now as we talked about on prior calls, we know our core competency is buying, leasing, operating, building buildings. It's not as a lender. So to the extent that we're going to look at other parts of the capital stack, we would like there to be a path towards ownership. And not sure that we can guarantee that. But if we're thinking that we're just going to lend and then get repaid, that's generally not what we think is the highest and best use of our capital. So today, most of what we're looking at are acquisitions, haven't bought anything yet. But as we touched on, on the last call, we're seeing more opportunities and -- both in terms of quality -- quantity and quality. And so it still sort of remains to be determined how assets will get priced, but it is something that we're spending quite a bit more time on.

Just to clarify, when you say quality, is it already a fully leased building or are you looking for that opportunity to reposition that asset from a leasing standpoint?

Yes. So we'll look at everything. I mean, generally, we are looking for ways to add value with an acquisition, and we have bought [ Core ], but we would have to -- there have to be something else going on there that makes our capital the best capital for that opportunity. So generally, what we've seen is maybe there's a building with a little bit of lease-up and the market dynamics are encouraging, or maybe there's a building that has in-place cash flow, and there's some time before the leases roll, and that presents opportunity because you're not really taking market risk today and you're getting some cash flow to sort of tie you over until the leases come due.

And I think Austin continues to be a market that surprises. We've seen a few large deals being signed over the last 18 months, most recently, IBM coming back to the market. I'm just curious how you're thinking about Stadium Tower, the opportunity there? Did IBM approach you for that site? Or...

We've talked to a number of different people in the market looking for larger blocks of space in the domain submarket in Austin in particular. We feel really convicted about the site we have. It's location, it's proximity to transit, it's proximity to the amenities in the domain. So we feel great about the site we have. We're going to be really thoughtful. I mean part of the -- Austin is dealing both in the CBD and in domain with no shortage of new supply right now. And so in order to commence a development project, you really would want to do something that was either fully -- basically fully pre-leased, right, to build a building and take significant additional spec risk outside of the anchor tenant. It's a little bit more difficult in a market right now that's got this much new supply coming as the Austin market does today. So we'll continue to evaluate and again, feel really convicted in the quality of our site, and we'll pick the right time to execute that.

And Rob, maybe shifting over to the top question that you're probably getting in all your meetings. How is demand activity trending in San Francisco, Silicon Valley -- any updates on the leasing pipeline?

Sure. What I would say, hello, everybody, by the way. We're positively disposed right now towards San Francisco and what's happening. There's -- on the political front, we have a mayoral election coming up as well as the Board of Supervisors rebalancing. And we think that in both cases, that will lean more towards a business-friendly environment, still be progressive, but a more business-friendly environment, which only bodes well for the city. From a specific office demand point of view, we're in the third quarter now of sustained 6-point -- right now, 6.8 million square feet of demand for office space. And we're hoping that trend continues. It feels like it will this quarter. There are some large transactions pending that should happen by the end of the year. And we're seeing technology being an active player in the market more than they have. About 50% of the demand in San Francisco right now is technology and a component of that is AI, which I'm sure everybody reads about and ask about. But, AI is the epicenter for or San Francisco is the epicenter for AI in terms of just developing companies. And we're seeing kind of a broad range of companies. There are 16 potential transactions right now in San Francisco, over 100,000 feet, which aligns very nicely to what was happening in 2017, '18, '19, there are almost 80 deals that are 15,000 feet or less. So you've got this kind of barbell and the middle tier is not quite as busy, but what that tells us and based on what we see a lot of activity is in the smaller companies and company formation space. And that means you have to have space that's ready and turnkey ready, meaning someone can move in tomorrow. And you are dealing with many companies that don't know what their footprint is. So it's really -- we try to become a strategic partner with them in terms of what their initial takedown is and how they can grow to the extent they do grow in the future.

I think Rob made a really important point about just the total amount of demand you're seeing in San Francisco right now. And just what I would note is that 6.8 million square feet number of just total tenant demand in the market has been pretty steady over the last couple of quarters despite the fact that executions have really picked up. So that means we are backfilling that pipeline of demand with new tenants coming to market even as things are getting executed at a higher rate.

And can you bring that back to like Kilroy, your leasing team, how much your activity you're tracking? And has that changed since the second quarter?

Yes. I mean we're -- again, a lot of this, I should have said this, but a lot of this has happened in a very quick time frame, meaning this AI demand has really picked up probably starting in summer to now. So it's been a relatively quick uptick. But if you look at the average size of an AI company in '23, it was about 5,000 feet. They're now 15,000 feet. So they're growing quickly, and there are more tenants. And our pipeline, it depends on the building like 100 1st in the Salesforce campus is, they're all desirable locations, but that 1 because of the proximity to Salesforce, part, et cetera, always does well. 201 3rd Street, we're completing a renovation there, which will help reintroduce the project to the market. And it's all about -- it's all about renovations, having market-ready space, having the amenities that tenants want, whether they're on site or whether they're walkable. So our pipeline has, I'd say, increased over the probably last year.

There's some question, there's plenty of availability and spaces for tenants to look at in a market like San Francisco and this is where our proactivity on the part of Rob's team is critically important to making sure that we're getting in front of as many of those requirements as we can where we have space that might fit them. And Rob really made a critical point. The company has made some very smart and very strategic decisions to spec out more suites and certain assets, just to be able to hit the market or respond to the market where it is today, which is in some of these smaller format, spaces, and tenants looking to take occupancy as quickly as possible, right? The AI demand we're seeing in the market. These are not tenants in general -- at that -- certainly, at that square footage size that are going to take space and spend the next 12 to 18 months building out a location, right? They're taking space and they want to be in, in the next month or 2. And so that's where the spec suite program. And doing so, really thinking about how we execute that program, being very conscious about capital, doing everything we can to make sure that the capital we're putting into those suites can and will be reused on the other side when that tenant hopefully grows within the portfolio somewhere else is really, really important. But that's kind of a long way to making sure that we're already in a position to meet the demand that's coming.

Okay. And Angela, you remain very committed to life science and Kilroy Oyster Point. I was wondering how -- I guess what brought you to that decision given the wall of supply that, that market is facing? And any updates on the tour activity, demand you're seeing there would be great?

Yes. I really believe that what this company has aggregated in terms of the campus at Oyster Point and what we're delivering -- what we did deliver in Phase 1 and what we're now delivering in the fourth quarter of this year at Phase 2 is very differentiated from anything else in the market. And Camille, you're right to point out that there is a pretty significant amount of new supply in South San Francisco right now, but our product is different than everything else delivering. We've got unbelievable amenities that have been put into this campus and some of which are just natural amenities in terms of the views and proximity to the Bay and Bay Trails and things like that. And I really believe that what we've aggregated here, we'll do incredibly well for the company over time. Phase 1 has been a real success. And while Phase 2 leasing, given what's happened over the course of last 18 months in terms of life science leasing and demand more broadly, but within South San Francisco, things have been slower, and we certainly wish we were at a point where we had more lease in Oyster Point today than we do. But I'm very convicted that as demand is coming back, and I'll touch on that a little more in a moment, but demand is coming back. And as that continues to happen, at the same time, that we are now in a position to deliver and to show people exactly what is being delivered in terms of the build-out and the quality of what we've done and the amenities and the spec suites. We really are, from a timing perspective, hitting the market at just the right time. The decisions the company made last year to even further improve the amenities in Phase 2 and to go multi-tenant on 1 building and build out the spec suites, and 1 of the 3 buildings we're delivering are incredibly important in terms of making sure, again, just like we were talking about with AI in San Francisco, we can respond to the market where it is. Any requirement that comes through the South San Francisco market, over the next few months, we could meet in some form or fashion. The smaller footprint leases we can meet in the spec suite multi-tenant building, but we've also preserved 2 of the buildings to the extent one of the larger format users that we have now seen touring again, comes back with a real commitment and decision to move forward. So we've got a tremendous amount of optionality embedded in Phase 2, and I'm very confident we're going to have a very successful Phase 2 project on the completion of the leasing here. The decision, as you look, we do have in the future land bank additional parcels at Oyster Point, which will facilitate the next several phases of development on that campus, I believe that as we continue to build out the Oyster Point campus, which we will do based on tenant demand, we won't go spec on another 900,000 feet again. But as we build that out in future phases based on tenant demand, some of which might just be in the market and some of which might come from tenants that we've already got in Phase 1 or we'll put into Phase 2, we're only going to continue to enhance the value of Phase 1 and Phase 2 as we do that. And so the ability to build -- I might feel differently about Oyster Point, if we only had 1 phase of this project, that was all we can do here, but the ability to build out a full campus and to bring in a stable of tenants that we can provide growth potential and optionality to is a critically important part of how we'll create value in life science overall, but specifically at Oyster Point.

But just going back to one of your key points in evaluating the land bank and how you have capital tied up. If we're -- like we heard earlier today in an environment for life science where it could be many years before that supply really gets absorbed. How do you think about keeping that investment on the balance sheet? And at what point do you start to reevaluate?

Well, look, we've got $1.3 billion in the future land pipeline, right? So as we sort of approach this from an order of operations standpoint, I would say the parcel within that $1.3 billion that I feel the most strongly about is Oyster Point, both in terms of the timing and visibility and conviction I have that it will be developed at the right time and in a way that creates significant value for the company, including that strategic point about enhancing the value we've already delivered at Phase 1 and Phase 2. That's part of what makes that calculus on the Oyster Point land different from other things in the future land bank. But to your point, we are and have talked publicly about the broader evaluation we've done of the land bank overall, and the acknowledgment we've made, that $1.3 billion in carry costs in the future land pipeline, given the changing dynamics in office and life science, it was appropriate when I joined the company to take a big step back and revisit that pipeline. Think about what the original investment thesis was, think about what's most likely now and think about really what the highest and best use for each of those parcels are. I'm not attached, I guess I'm a little attached to the Oyster Point based on all of my -- the comments just now. I'm attached to Oyster Point, but everything else I'm pretty even on. And we are -- we have already identified a number of parcels within the land bank that we think have the highest and best use that something outside of our core competency of office and life science development in most cases, but not all, the highest and best use is probably residential. And there's an active and liquid market for those sites today. The question is, and this just comes down to math, the question is whether or not we sell those parcels today with entitlements in place for office or life science to somebody else that will reentitle them and create the value that comes through the reentitlement process for their own account or whether or not we hold those and carry them through a reentitlement period, and we -- that benefit accrues to us. And that's just a math question of how long you think the entitlements are going to take and what the difference between those 2 numbers is. As I mentioned on this earnings call, we think in most cases, it's going to make sense for us to hold those assets and carry them through the reentitlement. That's going to be the path that creates the most value for shareholders. And so it is going to take us time to realize proceeds on some of those parcels, but we're convicted it's the right thing to do. And we hope that over the coming quarters, we'll have more to share in terms of potential proceeds and potential timing as well.

I think we spent a lot of time on the land bank. So maybe shifting over to your Los Angeles market. When you look across where the vacancy is concentrated there, for instance, Culver City or [indiscernible] sunset with Sunset Hollywood. Can you just discuss your latest thoughts on how you plan to address these vacancies?

So our assets in Hollywood, we have Sunset Media Center, which is a 22-storey high-rise. We also have Columbia Square, which is a creative campus that has some vacancy in it. And we have the Netflix campus, which is residential and office and fully leased to Netflix. So with respect to the Creative Campus at Columbia Square, we continue to do well there with the vacancy we have. We only have about 45,000 feet left. And we just, I think, a quarter ago, signed a lease with Edelman, PR firm, Global PR firm. So it continues to attract the type of tenant, not only entertainment-related tenant, but tenants in that sort of public relations or PR type space. Sunset Media Center does have vacancy, but it's arguably -- even the competition says it's the best high rise in Hollywood. And so it's a matter of a lot of pick and shovel work going after smaller tenants that are in the market, and really creating a value proposition for them with -- we've upgraded the lobby slightly and some of the landscaping and redone how our parking operations work. So those are the things that make a difference what a day in the life is at the project. West L.A., a little bit of a different story. There's just -- there's a lot of space on the market in West L.A., particularly in Playa Vista. That happened before or during the pandemic, where we got almost the same amount of space on the market as we have today, that space did get absorbed relatively quickly. Today, there's just a void of tenant demand. So it's not only just the big tenants, it's also the sort of bread and butter tenant for Santa Monica, which is usually sort of a sole proprietor sort of production company or production-related company, but we fully believe that, that will come back and Westside Media Center, we're just completing in October, a renovation of our lobby. We have a really wonderful outdoor space in back. We have the LA Metro right behind us. So again, we think we have a really good value proposition, particularly if you look at how those assets have leased over time, they've had some larger tenants like Fandango or Red Bull, but by and large, most of them have been smaller production or content creators that are private that live on the west side of L.A.

Yes. And then Culver City, in particular, our asset there is Blackwelder. It's a really interesting project with a number of different small buildings on site that can accommodate single users, they get their own small building. So it's just a really unique project. We had a couple of larger move-outs companies that have started there in smaller footprints and grown over time. A couple of larger move-outs over the course of the last year or so. But I feel like the marketing plan we have in place for that asset is great, and it's a really unique and differentiated asset, sort of the opposite of commodity space.

I do have some rapid-fire questions and this probably isn't a fair question for Jeffrey, given it's been less than a month, but...

I am just happy to jump in.

I'm wondering how you're thinking about the balance sheet today and any core principles you've learned in your [indiscernible] that you're planning to bring over?

Good news is Eliott did a lot of work here. So the balance sheet is in great shape. Maturities for '24 [indiscernible]. So we have cash on hand to deal with that. The real question is kind of looking out and how to stagger the rest of the maturities. So we're very committed to being an unsecured borrower. So pretty much no change. So that's going to be a very kind of smooth transition. The big question for me internally is how do we get our arms around data and really take all the great context that Rob and his team have in the markets and Eliott's experience. And how do we get that synthesized in a way to get leverage.

Thank you. With that, I'll go into the rapid fire questions. Do you expect real estate transactions to increase once the Fed starts to cut? If so, is that the fourth quarter of this year? First half of next year or back half of 2025?

I do think activity will pick up when the Fed cuts, and you're asking when the activity picks up or when the Fed cuts?

When the activity picks up?

First quarter -- first half of the next year.

And how would you characterize demand for space today, improving, steady or weakening?

Improving.

Finally, around AI spend initiatives for next year? Or are you planning to pick that up, stay flat or lower?

Picking it up, but off a pretty low base.

All right. Thank you.

Thanks, everybody.