Kilroy Realty Corporation (KRC) Earnings Call Transcript & Summary

So good afternoon, everyone. Welcome to Bank of America's 2026 Global Real Estate Conference. I'm Yana Galan, BofA's Altice REIT analyst, and we're pleased to have with us Kilroy CEO, Angela Aman; CIO and Interim CFO, Elliott Trencher, Chief Leasing Officer, Rob Peretti and Investor Relations and Capital Markets, John Perry. I'll turn over to the mic to Angela for opening remarks, and then we can jump into Q&A.

Great. Sounds good. Thank you, and thank you for having us. We're happy to be with all of you today. And happy to be here to tell the story about Kilroy and what's been going on in our markets and across our portfolio over the last couple of years. For those of you who aren't familiar with the company, we are Westcoasd based company, science assets across the West Coast and in Austin, Texas. It's a very high-quality portfolio and a bout of the portfolio is actually in the San Francisco Bay Area, which a few years ago, if we were at this conference would have been the most challenging part of the story and now has become 1 of the most exciting parts of the story given the momentum we're seeing in that market from sort of a wide breadth of tenants, including those tenants in the AI and tech space, but more broadly across other sectors, professional services, legal, et cetera. We have been experiencing, I think, across all of our markets, a real inflection over the last few quarters in leasing volume and momentum and activity. It's been most pronounced, certainly in the San Francisco Bay area. But as Rob will touch on later, I'm sure. We're seeing good activity and momentum in the Pacific Northwest in our portfolio in Bellevue, and that activity in Bellevue is now spilling over into the Seattle side of our portfolio, where we have a few high-quality assets in Denny Regrade and South Lake Union up through Fremont, we've seen very strong activity really over the last several years in our San Diego portfolio where we own a significant concentration of assets in Del Mar, which has been 1 of the best-performing West Coast office markets really over the course of the last cycle. We've seen recently a real uptick in activity in our Austin portfolio, where we have 1 significant asset there that has been in lease-up. And I think there's been a very exciting momentum around completing the lease-up of that project. And then Los Angeles, where the company is based has also seen some green shoots recently with activity in the defense and aerospace, robotics and advanced manufacturing sectors coming back to the South Bay where we have some vacancy and opportunity for portfolio improvements and really across the board, particularly in new assets we bought over the last couple of years in Beverly Hills primarily. So across the board, we feel like activity has returned and continues to get better. At the same time, over the last 3 years, we've been very intentional about improving and rationalizing the portfolio and being as thoughtful and strategic as we can be from a capital allocation perspective. So we've made, I think, some smart disposition decisions over the last few years both to take advantage of situations where we felt like we had maximized value in the portfolio and could raise really attractively priced capital to reinvest elsewhere and places in the portfolio where we we really felt our ability to create value and to drive cash flow over the longer term what's going to be compromised based on location or quality or just CapEx burden at some of those assets. All of our intentional efforts over the last couple of years, I think, have made this a more focused portfolio and a portfolio that's really well positioned for durable growth over the coming years.

Great. Maybe let's start with on the demand side, just the latest color across key markets, breadth of demand for AI versus traditional tech versus fire law professional services.

Yes. Yes, I'll jump in and then turn it over to Bob. Like I was mentioning, we've seen really good demand in the San Francisco Bay area. And that's -- there's sort of different pockets of activity happening in different parts of the market. Obviously, AI and the amount of leasing that's happening from an AI perspective, certainly receives the most headlines in the San Francisco CBD, and it certainly has been an important driver of activity and demand. We have assets in that market that really tell the full story of the inflection in the San Francisco market. So one asset that Rob and I like to talk about a lot is our 2013 Street asset that went from effectively fully leased down to about 20% occupancy with a big move out of a financial services user in the fourth quarter of 2024 and is now back to 90%. And that improvement has been through leasing up space to some larger, well-capitalized later-stage kind of AI and tech companies and also a very intentional spec suites program that's been able to tap into some of that earlier stage AI demand that's spend in the market. In addition to some more traditional firms, we did a full floor deal with a streaming use. There's been other activity in the building that I think just points to that broad-based the demand and activity has been in that market. So it's a great story of sort of a full ride in San Francisco and how quickly activity has really improved and come back. As we look at the broader San Francisco portfolio outside of AI and some of the tech-based uses that are at market. One of the key themes we've been seeing over the last really quarter has been kind of a resurgence in larger format activity and interest. Given the success of leasing over the last couple of years market-wide. And as I'm sure you're all very aware of, some of the market statistics about remaining vacancy in the market, we think it's important to really bifurcate that into what's truly competitive, supply in the space versus what is effectively obsolete or functionally obsolete space in the market. Right now, we think there's 35, 36 large contiguous blocks left in the city in total, that blocks over 100,000 square feet. And more than half of them are really not competitive to the type of product that Kilroy owns today. So probably 15 to 20 of those 35 or 36 opportunities are truly competitive to what we own. And right now in the market, you've got 31 tenants looking for space about 100,000 square feet. So there's truly for some of those larger blocks of space, more demand in the market than there is supply to meet that demand. And where we've seen that show up in our portfolio, yes, is on the demand side for some of the larger contiguous blocks we have left. But as importantly, more larger format tenants in the market coming to speak with us about potential early renewal I think that speaks to 2 things. Certainly, the trend in rents and the inflection we've seen just in asking rate and net effective rents over the last year has been significant. And I think everybody is watching that trend closely. -- but increasingly, some of these tenants that have been in our portfolio for a while, are looking down the road, thinking about their exploration that might be coming a few years out and beginning to voice some concerns about locking in space today. particularly if you're in a building that has other vacancy or you're in a building that has another lease expiration coming up, I think people are becoming concerned. You could be displaced by a landlord looking at some of the bigger demands that or requirements that are in the market. So all of those are really healthy fundamentals, right, both on the occupancy side, you really are seeing rates start to move in these markets, which is very exciting as well. Further down the Peninsula and through Silicon Valley, you're seeing in addition to just the tech users that have really changed the way they're using space in some of those markets, some of them are taking significant sublease space off of the market over the course of the last year. We've seen a lot of demand and activity from robotics uses in those markets, and that's really been a driver of activity as well. Bellevue, we've seen good activity really over the course of the cycle over the course of the last few years in the Bellevue market have been able to push both occupancy and rate in that market for a while. Over the course of the last few quarters, we've seen more tension in the market on the Seattle side as well. We have 1 project that was subject to a major repositioning that delivered a couple of years ago, and it had been very quiet from a tour and demand perspective until probably 2 or 3 quarters ago. We completed that major repositioning, brand new lobbies, new food and beverage offerings, great outdoor space and amenities, conference facility, a fitness facility, everything that tenants are in the market we're looking for, but there's just isn't enough depth of demand on the Seattle side or in South Lake Union. And over the last 2, 2.5 quarters, we signed over 150,000 square feet of really high-quality leasing in that project. Several top-tier law firms a host of a Fortune 100 company looking for space, a financial services firm looking for space. Many of these tenants are kind of new to the market for the use they're looking for, so bringing in a tech group to take advantage of a highly educated, very deep tech talent pool that's resonant in the Seattle and Bellevue markets without sort of the start-up ecosystem that's competing for talent in markets like the San Francisco Bay Area. So that's been a really encouraging point as well. Santiago has been consistently strong. over the course of the last few years. We own about 40% of the market in Del Mar, in particular, which is high demographic, proximate to executive decision makers, and we've really been able to push rate pretty consistently over the last few years. I think about a year ago, we signed a lease and had mentioned on prior earnings calls that it was set a record at our One Paseo asset, which is a mixed-use project we own in the San Diego market. at the highest office rent that had ever been signed in San Diego County. So there's been good tension in that market. We have some very differentiated product in that market. In terms being able to provide that mixed-use environment that's been very compelling to tenants. And so that's been a fantastic market for us and our efforts there. And then in Austin, as I mentioned earlier, we own 1 building in the CBD. It's a 750,000 square foot building called indeed Tower where we've had lease-up to do there. And really also over the last quarter or 2, we've seen a significant uptick in tour activity and demand there and continue to work through the last pieces of that lease-up rents, capital, net effective rents have trended very well in that market for us as well. Don't leave anything else?

I'll just touch on a couple of points, Angelo made. When you look at the 2013 asset that Angela talked about in our lease-up going from 20% to almost 90, our effective rents were 30% higher than they were at the time we started. So I never thought in the short order that we've been talking about, that we'd be talking about rent growth in San Francisco. But right now, it's projected to have growth over the year. But clearly, in particular, assets like 2013 or other assets that have views over the right kind of space, the rent growth is substantially higher than that. I'd say another thing that's new to the market that we're tracking very closely is the robotics demand that Angela mentioned, there's 0.5 million square feet of robotics demand in San Francisco and $1.5 million on the Peninsula where our Oyster Point project is. And what's really interesting about that, the robotics companies, for the most part, have office and really lab use. So they're using lab space also. You're also seeing life science companies using robotics. So the demand profile at Oyster Point particularly is really amazing right now. We're very busy there. We have more tenants looking at our spec lab space than we have space. and we also have large users coming back to the market. The last point I'd make, and this is sort of focused on the Bay Area, but we're starting to see it in other markets for the first time in a long time, we've got tenants compete for the same space, and that's really important. We haven't seen that in a long time, and it shows that the quality space keeps continuing to decline, especially in the larger format uses. So we've had that happen in life science, and we've also had it in tech.

Yes. Sentiment has really improved on the life science side, right? We had been -- we had talked and had conversations with tenants really over the course of the last few years, particularly at KalraOyster Point and at Menlo Corporate Center, where we did a life science conversion for 1 of the buildings on that campus several years ago. And look, there were lots of tenants in the market who kind of knew they needed to upgrade their space to meet their business objectives but everybody was really just in a cautious kind of stance and that had to do with a lot of things, capital raising concerns. You just weren't seeing any capital recycling in that ecosystem from venture capital dollars that have been tied up for a very long time. And the combination of how the XBI, the biotech index has performed this year, it's up over 100%. I don't know about today, but over 100% over the course of the last year. That has sort of opened up the IPO and follow-on equity windows, which has been very positive, both from an actual capital recycling standpoint and also just from a sentiment standpoint and you pair that with what's happened in M&A in that space as you've got big pharma companies looking at patent expirations and that patent cliff the amount of revenue that's going to be lost associated with that. You've seen a lot of M&A activity in that space as well. Just another way you're seeing capital kind of be recycled in that space, or it's actual because tenants have raised capital as a result of all these things, or it is just a belief that the capital will be available when companies are ready to raise it. We've seen both management teams and the boards of some of these companies be more inclined to make longer-term commitments and to get space that's actually going to facilitate their growth objectives as a company. And that's a very different or very striking change in sentiment relative to where we were 12, 24 months ago. Within life science, can you maybe talk a little bit about your assets relative to market in South San Francisco and in San Diego?

And then very curious on kind of like the robotics use, what do you -- what would rent for that look like relative to more traditional life science rents?

Do you want to take that?

Sure. So -- and this isn't just us saying this, our Oyster Point project is best-in-class in the Oyster Point submarket, which is the main and main location for where life science wants to be. And with respect to pricing for robotics companies, it's sort of similar because a lot of our space shelf. So we're having to go from Purcell to a build-out that's partially lab. It might be a little bit cheaper to do a robotics company deal in a life science deal. But some of our life science deals have been cheaper too. It just -- it depends company by company. But Oyster Point is attracting attention from outside of the Bay Area. We have some companies that are outside of California actually that have looked and that are looking now. And so the amenities in terms of just the quality of product that's in the market, we've got water side amenities. We've got our fitness center gym business center and the project with tenants in it now is actually thriving. So that's created a lot of momentum. We also have Memo quick Center in the Menlo Park, which is also in Northern California where we have a smaller life science building, where we had a tenant that didn't make it several years back. We're now under discussion with the full in tenant. That's the example I gave 1 of the buildings where we had competition from 2 different tenants. And other trophy life science project is Nautilus, which Elliott acquired a year ago, I guess, in December, which we acquired from AR and inventory clients, which is arguably the next story pine you, but I'm really happy with that acquisition and the activity we're seeing.

Yes. I mean just to talk a little bit more and build on some of what Rob said about and how that lease has gone over the course of the last couple of years. As a reminder, we do 875,000 square feet in Phase II, split crossing 1 building has now been fully leased to UCSF, so a great, very stable use, high credit tenancy, et cetera. 1 building, we went multi-tenant on early, built some spec suites and had great success at kind of completing the lease-up of that building with a wide range of tenants all the general science and a combination of very well-capitalized private companies, public biotech company, et cetera. And then we have remaining that's arguably the best position building from an access and visibility perspective, we have project delivered and life science market was not what it is to that described. That market has continued to improve shift recently. But back when we delivered, we were very open to to the range of tendency we might see shop for that project. Obviously, it had been special purpose built for life science. But the of the project, which was also purposeful for life science, we have cytokinetics life science use and Stripe, so fintech use. So the project has worked well in prior phases for a wide range of uses here today is that between new CSS and the use that they'll be putting into their building and the way the multi-tenant building lease-up has gone, we've got a great stable of life science tenants at sort of all different sizes and ranges in that multi-tenant building. And with UCSF as an anchor and validation of the project, we continue to build a lot of excitement in the life science community, in particular, around the ecosystem we're building at Phase 2 of this project and already have in Phase I -- many of you are aware, but we have land at Oyster Point for future development at Oyster Point, basis 3, 4 and 5 down the road. And we were always hopeful when we began the lease-up of this project that we'd be able to build that kind of life science ecosystem that would provide a pipeline of growth for future phases of the project. But again, we're pretty agnostic about where the initial leasing demand would come from. And it's very exciting, I think, to everybody on the team that we have seen that life science demand that's going to facilitate future growth at the project. And you're seeing it now in the pipeline at the project. There's a lot of buzz in the market about the types of tenants we brought in. And again, that ecosystem that we're creating with life science tenants that want to be approximate to each other and feel good about the growth and the activity of that project.

Great. And then maybe just turning to San Francisco and the tremendous upswing in that market. Wondering if you could talk a little bit more about your Flower Mart site and potential opportunities there.

Yes. So we have a site called the Flower Mart site in the Central SoMa District in San Francisco. It was bought with the intention that it would be a large-scale development project. We have a development agreement currently on the site that will fit and entitlements for about 2.4 million square feet of commercial development, primarily office, a little bit of a retail component as well. We began a process a couple of years ago, given the changes in the San Francisco market and the changes certainly in the office market in particular, and engaging with the city around how we could potentially work through changes to the development agreement that would give us more flexibility and optionality on the site to ultimately be able to build a different mix of uses than what was originally envisioned. And we're very intentional as we went through this process, given our historical experience with the San Francisco market and the knowledge I think everybody in this room has a San Francisco has been from a commercial real estate perspective, historically, a bit of a boom bust market. it has recovered quickly in a number of different cycles, and we knew this would be an elongated process to get that kind of flexibility and optionality. And the last thing we wanted to do was pick a path and go through an extended entitlement process only to get to the end of it and realize our original plan was actually the right one. The city has been a wonderful partner to us as we've worked through this. And we feel good that we're making really constructive progress towards a plan that would provide with the Board of Supervisors approval, additional flexibility and optionality on the site that will really allow us to meet the needs of the Central SoMa community earlier than we potentially otherwise could have. We are very open-minded about what the actual execution path here looks like. It's going to be driven by market conditions. We've talked about it on prior earnings calls, but even if we have all this flexibility and optionality, residential and commercial rents are still yet at a place where new development would pencil, but they're getting closer all the time. And so we hope and expect that we'll be through this process with the city on sort of reimagining the approval path for the Flower Mart by the end of this year, and then we'll really be in a bit of a holding pattern as we wait to see which which use or which mix of uses ultimately makes sense for development to commence at site. And then now maybe turning to L.A., this market overall has remained a bit more challenged, but you guys have done some capital recycling there into different submarkets. Curious if you could talk about that. And then also, you did mention some green shoots the second quarter call.

Yes. I mean I'll start, and I want both Elliott and Rob to speak to this. But maybe to zoom out for a minute just from the L.A. portfolio and talk about the capital allocation strategy more broadly. As I mentioned at the beginning, we are in 5 markets, primarily West Coast and then Austin, Texas that are all high-growth markets, but also have been historically higher volatility markets. And as we think about how to put this company in the best position to consistently produce for shareholders over time, we really think there's an opportunity here to focus a bit more on the durability side of the equation and manage some of that volatility without giving up the excess growth that these markets typically have over the course of cycle. So that's sort of the strategy from a zoomed-out kind of 10,000 square foot perspective. Out of all of our markets, I would say, we've been clear since the beginning or since I joined that L.A., we probably have the most repositioning work to do. Our portfolio, and we have had a few assets when I got here on the west side, we had assets in Hollywood, sort of 3 commercial assets and 2 residential assets. there are submarket. We have 1 asset in Culver City and then assets in the South Bay. Also go no down through Long Beach. There are some markets that have continued to perform really well in Los Angeles, despite some of the headlines we see about the L.A. market, City has been an outstanding office market over the course of the last cycle. Beverly Hills has been an outstanding office market over the course of the last cycle. Culver City has continued to tap into tech and streaming and other kind of content creation that kind of continues to work in that market. So it's all been very positive, but our exposure in those submarkets was either nonexistent or quite limited. So we've done things to intentionally reduce exposure in Santa Monica -- we sold a lower quality asset in the Santa Monica market. We sold our lowest quality asset in the Hod market. We also sold 2 of our 3 residential buildings, the 2 that were in the Hollywood market. So over the last 3 years, we've taken $300 almost $300 million of capital between $250 million and $300 million of capital out of the Hollywood market as an example. We did find an opportunity last year to acquire an asset in the Beverly Hills market, and that audit has been very successful for us. We've continued to exceed underwriting both from an occupancy and a rate perspective in that market given some unique dynamics in the micro market in which that's located?

And can you look for opportunities, again, just on that the general framework of how do we reduce some of the volatility in the portfolio. and tap into specific submarkets and micro locations in markets like L.A. that are going to be most successful at driving growth over time. to anything else on the capital allocation.

Maybe just to add to that, as we thought about firing in Beverly Hills. We looked at a lot of different things, including barriers to entry, which are quite high there. Not that it's easy in a lot of parts of L.A., but Beverly Hills in particular, it's very difficult to build. We also were tracking how the supply in the micro location was really changing over time with a lot of owner users coming in and acquiring real estate there. So it's really a multifaceted process for us. But given some of the pockets that Angela pointed out. I think that we're going to keep our eyes open. And if we see opportunities there that economically makes sense, we won't be afraid to pursue them. The only other thing I'd touch on is that as Angelo said, we're exceeding underwriting at Maple Plaza, which is just a terrifically located project and a really great micro market of Beverly Hills. And hear me talk about micro markets a lot in L.A. because there are so many markets Culver City has done really well for us also our Black older project. And we've really seen since we acquired the asset, how the tenant base there has changed, there's been some. There was a lot of entertainment in the past, and now we're seeing a lot more fintech. We're seeing some and we continue every month to enter into new leases with companies there. So it's a really fun project to work on. It's 12 buildings and it's sort of a at kind of architectural design for that part of the market that works perfectly. And so we're really happy with that. We are seeing some -- you mentioned green shoots. We did a lease in the second quarter with Universal Music Group. There was a full building lease that was about 50,000 feet in Santa Monica. That is the largest lease to have been signed in Santa Monica, new lease, not renewal since the pandemic. And so as you said in your question, some of L.A. has recuperated slower than other submarkets within L.A., but we're starting to see more activity and expect to see more this all on our assets on the west side.

I mean, LA is 1 of the largest economies in the country. And I don't think we should lose sight of that. I know entertainment as the headline gets a lot of focus in the L.A. market. It is a piece of the market but it is -- L.A. is a much more well-diversified economy than certainly, I appreciate it before relocating there. And I guess as we look at 2027, are there any larger expirations or renewal still up for debate that you want to flag and just also latest thoughts on DIRECTV. You want to on that?

Yes. So Jan, you really hit on the big one. DIRECTV is our largest maturity in 2027. It's about 500,000 square feet plus or minus at a campus in Alsagundo. We have said on prior calls and our expectation continues to be that they will give back the majority of that space, if not all of the space. So we would expect to vacate or material downsize. Outside of that, our role is pretty granular. And so we feel that it should, that bodes well for what that means in terms of 2027. And maybe taking that 1 step further into the DIRECTV campus itself, we continue to evaluate lots of different alternatives there in terms of ways to maximize value. and we're evaluating all of those real time. We're not going to wait until the fourth quarter of 2027 when that expiration happens. So we're actively working on a few different alternatives. We're also going through a parcelization of the campus for those that are not familiar with the campus that has 3 different buildings. And so to put a parcelization map in place, just improves flexibility and optionality as we evaluate our alternatives there.