Kilroy Realty Corp Q2 FY2022 Earnings Call

Good morning, ladies and gentlemen. Thank you for attending today's Q2 2022 Kilroy Realty Corporation Earnings Conference Call. My name is Tia and I will be your moderator for today's call. I will now pass the conference over to your host, Bill Hutcheson, Senior Vice President, Investor Relations and Capital Markets. You may proceed.

Thank you, Tia. Good morning, everyone and thanks for joining us. On the call with me today are John Kilroy, our Chairman and CEO; Tyler Rose, our President; Rob Paratte, our Executive Vice President of Leasing and Business Development; and Eliott Trencher, our CIO and Interim CFO. At the outset, I need to say that some of the information we will be discussing during this call is forward-looking in nature. Please refer to our supplemental package for a statement regarding the forward-looking information on this call and in the supplemental. This call is being telecast live on our website and will be available for replay for the next eight days, both by phone and over the Internet. Our earnings release and supplemental package have been filed on a Form 8-K with the SEC, and both are available on our website. John will start the call with second quarter highlights, and Eliott will discuss our financial results and provide you with updated 2022 earnings guidance. Then we'll be happy to take your questions. John?

Thanks, Bill. Hello, everybody and thank you for joining us today. I want to begin with some big picture comments and then review highlights from this quarter. The economy during the second quarter continues to show fits and starts. Elevated risk exists given stubborn inflation levels, bearish equity markets and heightened geopolitical tension. On the other end, unemployment remains low, the dollar strengthened, commodity prices are starting to decline and public capital markets remain open and functional. The economic signals are mixed, in some ways complicated. In periods of uncertainty such as this, we believe it is prudent to err on the side of caution. Despite the mixed macro trend, the technology and life science sectors continue to demonstrate encouraging signs. VC capital deployment remains robust. In the first half of 2022, $144 billion was invested, which roughly matches the full-year deployment levels for both of 2018 and 2019. While ICO expects that the VC backed companies have been slow, this is not impacting capital raising in most cases when compared to historical volumes. Funds have raised $122 billion year-to-date which is on pace to be the best year by a significant margin. The labor market also remains competitive. Nationally there's twice as many job postings as unemployed people. In our markets, postings are up roughly 40% year-over-year for large-cap tech companies, highlighting the continued need for talent on the West Coast and in Austin. While leasing in periods such as these is understandably choppy, we remain confident about the long-term health of these critical industries and are cautiously optimistic on the continued demand for space at our properties. The progress of return to office continues across our portfolio with some differences across geography and industry. Austin and Southern California have been geographic leaders, while professional services, life sciences and technology have been the industry leaders. Noticeably, these sectors have contributed to more activity in our leasing pipeline, highlighting the appeal of our properties to a range of tenants. Physical occupancy in our portfolio and the overall market continues to improve, and based on conversations with our customer base, we remain optimistic this trend will continue. In light of the current economic uncertainty and the potential impacts on the labor market, the power dynamic is shifting to employers who have consistently expressed the preference for in-person work. Additionally, it's worth noting the pace of return to office data aggregated by Google, the UK, Germany, Japan, and Hong Kong are 15 to 30 percentage points ahead of the U.S., suggesting there's upside in physical occupancy in the short and medium term. Notwithstanding varying rates of pre-occupancy in our markets, tenants continue to show their commitment to the office by leasing space. According to JLL, second quarter office leasing nationwide was up slightly from last quarter, marking the sixth consecutive quarter of increasing volume with technology representing the largest industry of demand. While some companies are slowing their decision-making processes, others including Google, Apple, and Amazon have signed major leases in our markets this quarter. The headlines indicating that many technology thought leaders are still figuring out what hybrid work looks like for their employee base is accurate. To that end, some users are slowing down their build-outs in order to experiment with different layouts and configurations. While this may create some noise in the short-term, it sets companies up to make better long-term decisions which will ultimately favor high-quality and efficient buildings like those we own. Political winds in our markets are also shifting. The actions taken by San Francisco voters over the past several months, starting with the recall of three Board of Education members, and most recently last month, the recall of former District Attorney Boudin is a clear sign that voters are demanding change. The subsequent appointment of a law-and-order DA, District Attorney Jenkins, combined with major changes of her staff and increased budgets for police funding, indicates that disgruntled voters are demanding accountability from their elected officials and we're pleased to see that. These changes in San Francisco come on the heels of Seattle voters taking action late last year when they elected a business-friendly law & order mayor and city attorneys. In Los Angeles, similar movements are afoot. The theme we continue to see across markets is the preference for high-quality office space. Tenants have more choices today and they want to be in newer and highly amenitized buildings. Leasing the best product in desirable locations is critical for companies to attract their employee base back to the office. The data supports this, as according to CBRE, effective rents in top-tier office buildings nationwide have increased roughly 8% since 2020, while lower-tier office rents have decreased by 3% over the same period. As more companies seek the newest and best buildings, we believe our modern and sustainable portfolio with an average age of 11 years is well-positioned to capitalize on this trend. Turning to highlights from the second quarter, we signed roughly 250,000 square feet of leases with cash spreads in the stabilized portfolio of plus 21%. Subsequent to quarter-end, we signed an additional 73,000 square feet in the stabilized portfolio, highlighted by a five-and-a-half-year renewal of a financial services tenant in Menlo Park. On our last earnings call, we referenced 350,000 square feet of builds in late-stage negotiations. As of today, we have executed on more than 90% of that number, with much of the balance remaining in ongoing discussions. The activity combined with our modest rollover increased our percentage leased by 60 basis points from last quarter to roughly 94%. Looking forward, demand in the leasing pipeline is solid, both in our core portfolio and also for our projects under development. We have a number of transactions across the stabilized portfolio in various stages of negotiation and expect to have continued activity over the balance of the year. Our development pipeline also shows strong interest specifically in 2100 Kettner, Indeed Tower, and KOP Phase 2. Demand is coming from life sciences, technology, finance, and professional services. Negotiations continue to progress despite recent market volatility. While there can be no guarantees until leases are actually signed, we are encouraged by the advanced discussions and expect that they will result in good news. On the capital allocation front, we intend to use caution when evaluating new investments and new development starts. The bar for us to make meaningful acquisitions or start something new on a speculative basis is higher than three months ago. Having said this, we maintain high conviction in our recent acquisition of the site in Austin after the development of our Stadium Tower project and we expect to begin construction later this quarter. The Austin market remains strong and capable of supporting new development. The area around Stadium Tower is one of the most vibrant in the region anchored by companies including Meta, Amazon, and most recently, PayPal, who just signed 60,000 square feet this month. Light rail that will service the area recently had a groundbreaking last week and nearby, a nearly 500,000 square foot project is set to be state-of-the-art with desirable floor spaces, outdoor amenity areas, and 50,000 square feet of walkable retail. Construction is projected to take 30 months and the project will be ready by the first half of 2025. Now let's shift to the real estate capital markets. Volatility in the debt market has made it tough for borrowers to get quotes and has limited price discovery. Additionally, landlords are much better capitalized today than in prior cycles, so there are not many poor sellers. As a result, very little is traded, while we are maintaining our 2022 disposition guides of $200 million to $500 million, we will only proceed with sales if we feel it is the appropriate capital allocation decision. In summary, the company is very well-positioned for both defense and offense. Our downside is protected by our strong balance sheet, minimal lease and debt maturities, diversified tenant credit, and top-notch portfolio quality. And when the time is right, we expect that our development pipeline and capital allocation abilities will generate upside and create meaningful value for shareholders. That completes my remarks. Now I’ll turn the call over to Eliott.

Thank you, John. FFO was $1.17 per share in the second quarter. This includes roughly $0.02 of non-recurring items from tenant catch-up payments and retail tenants going back onto accrual accounting. The increase in FFO relative to last quarter was mainly driven by the balance of 333 Dexter coming into service in mid-April. On a same-store basis, second quarter cash NOI was up more than 10%. The growth was driven by free rent burn-off for some larger office leases, improved parking revenue, and higher occupancy at One Paseo residential. GAAP same-store NOI was up 3.5%. At the end of the quarter, our stabilized portfolio was 91% occupied and 94% leased. The increase in occupancy from the prior quarter was due to the balance of 333 Dexter coming into service and the transition of our 26th Street property in Santa Monica into the future development pipeline. The increase in percentage leased was driven by the deals we signed during the quarter, specifically in Long Beach and the I-15 corridor in San Diego. Turning to the balance sheet, our liquidity today stands at approximately $1.2 billion, including roughly $120 million in cash and full availability of our $1.1 billion revolver. Our cash on hand, unused line capacity, and projected dispositions are more than sufficient to fund the balance of our projects under construction. Net debt to 2Q annualized EBITDA was 6 times, and we have no debt maturities until December of 2024. Now let's discuss our updated 2022 guidance. To begin, let me remind you that we approach our near-term performance forecasting with a high degree of caution given all the uncertainties in today's economy. Our current guidance reflects information and market intelligence as we know it today. Any COVID-related impact or significant shift in the economy, our markets, tenant demand, construction costs, or new supply going forward could have a meaningful impact on our results in ways not currently reflected in our analysis. Projected revenue recognition dates are subject to several factors that we can't control, including the timing of tenant occupancies. With those caveats, our updated assumptions for 2022 are as follows: as always, no acquisitions are forecasted. We continue to assume $200 million to $500 million in dispositions. We now expect the majority of these sales to happen in the fourth quarter. As John mentioned, if the capital markets are not supportive, we are not going to force the issue in 2022. Development spending for the balance of the year is expected to be $300 million to $350 million, a decrease from our prior full-year forecast due to the expectation of fewer new starts. We expect to commence revenue recognition for 250,000 square feet of life science redevelopment during the fourth quarter of this year. Year-end occupancy is projected to be 91% to 92% for the office portfolio and residential occupancy is projected to remain around the current level of 94%. It is important to note that 2100 Kettner will be coming into the stabilized portfolio next quarter. As the building is not yet leased, stabilized occupancy for the company will be impacted for the balance of the year. As a result, we expect to be at the lower end of the occupancy range. Same-store cash NOI growth is still expected to be between 5% and 6%. As implied by our guidance, same-store will decrease in the back half of the year due to some tenant concessions that will go into effect and some one-time items in the prior period. Putting this all together, our updated 2022 FFO guidance is projected to range between $4.53 and $4.63 with a midpoint of $4.58, which is a $0.07 increase compared to our prior guidance. The increase is due to the solid second quarter results and the adjusted timing on our dispositions. These $0.04 can be broken down as follows: $0.02 from non-recurring items previously discussed and $0.02 from dispositions. That completes my remarks. Now we’ll be happy to take your questions. Tia?

Absolutely. We will now begin the question-and-answer session. The first question is from the line of Nick Yulico with Scotiabank. You may proceed.

Hi everyone. First question, could you provide insight into the leasing demand in the Oyster Point market right now? I understand there has been some concern regarding the biotech index and DC funding, which may have contributed to a slowdown in demand. I would appreciate it if you could outline your current perspective on demand in that market compared to earlier this year.

Sure. Nick, this is Rob Paratte. How are you doing? So recently within the last 20 days, two leases in the South San Francisco region, life science leases have been signed totaling in excess of 435,000 square feet with both being great tenant names. I think that's an indicator of where the market is for very high-quality space. As John mentioned in his comments, we're seeing a lot of activity at Kilroy Oyster Point Phase 2; our team there is actively engaged. We had meetings yesterday with a large user. We have a few users that could take entire buildings that we're talking to, and we're also speaking to tenants that could take portions of buildings. So for the product we have and the type of tenant we're seeking, our activities still remain very encouraging. Physically on the site, tower cranes will be up and visible from the freeway within the next 30 to 45 days. So a lot is happening on site and just the visibility of what's happening is positively impacting the conversations we're having with tenants.

Okay. Thanks, Rob. And a follow-up on that is, I think that the stabilization date got pushed out a bit farther on the project this quarter. Can you just talk about what drove that?

Hey Nick, this is Eliott. I can take that. The reason for the adjustment was because there was a change in the timing tied to the removal of an existing gas line by the utility company. They just took a little bit longer to remove the gas line than we had anticipated. So one of the buildings, remember there are three buildings, is going to deliver a little bit later because of that adjustment. The other two are not going to be impacted to the same degree. And as a reminder, our stabilization dates have 12 months of leasing baked into them. So just the takeaway here is it was more tied to the removal of a gas line than our view on the market.

Okay. Thanks. Just one last question is, as we're thinking about heading into next year, major expirations you have to deal with next year. I mean, is there any update you have there on car leasing traction just as we're trying to think about how occupancy could trend next year? I know it's early, but some companies are starting to get a little bit of a feel for that. Thanks.

Yes. Hi Nick, it's Rob again. So we have four expirations in 2023 that are over 100,000 feet. Three of them are in active negotiations and the fourth one, which is the smallest of the four, we expect will be a move-out, but that's not 100% certain yet.

Thank you. The next question is from the line of John Kim with BMO Capital Markets. You may proceed.

Thank you. I was wondering, John, if it's a pullback in tech hiring and potentially office space, do you think the newer non-headquartered markets like Austin will be impacted more by retrenchment or would the losses be more significant in Silicon Valley, just given the higher cost structure?

I don't know. I can speculate a lot, but I just don't know. The current sentiment is that people want to return to the office; they want to be in locations that can attract the talent they need. In Austin, we are aware of several companies looking to either expand significantly or relocate there, as shown by Indeed Tower. We’re noticing this in our initial stages of discussions or proposals related to our planned Stadium Tower. Overall, I believe our market is going to perform well. Everything we're hearing indicates that businesses are continuing to expand. When we connect with law firms and other entities in the area, including some venture capitalists linked to Indeed Tower, they forecast an increase in their business activities in Austin. That’s encouraging. Regarding San Francisco, there’s a lot happening; we’ve seen recent news about companies both expanding and some opting to sublease. It’s difficult to say definitively, but I believe we will continue to see buildings in Downtown San Francisco and other areas repopulated. We’re witnessing significant growth in San Diego and expect more to come, and there’s notable growth in Austin as well. In Los Angeles, there has been a rise in activity, with several lease deals completed. The situation is quite varied, and it’s hard to predict, but I am cautiously optimistic because we are seeing increased property tours by major users who are genuinely interested. However, the timing for decisions from many companies has stretched out, as they face additional challenges in justifying their choices. As I mentioned in my formal remarks, they are still determining how to improve their spaces and which model to adopt. We have seen some tenants reconfigure their space designs and make substantial changes. There are a lot of factors at play; while not everything is positive, I am noticing more positive developments now compared to last quarter.

I appreciate your honesty in your comments. My second question is on Blackstone. They've had a position in your company for the last couple of years. I'm wondering if you had any direct conversations with them either as a long-term shareholder, or potentially as a strategic partner?

I'm sorry, John, for some reason, you cut out a lot on that. And I'm not sure I got your question. Could you restate it please?

Sure. Blackstone has been a shareholder of your company for a while. I'm wondering if you've had any direct conversations with them either as a shareholder or as a partner.

I'm not aware of any.

I thought it's announced. Thank you.

I only want to clarify that it's somewhat of a question. I don't believe anyone else in the company has had any conversations with them. I certainly haven't and I haven't heard of any.

No.

Thanks.

Thank you. The next question is from the line of James Feldman with Bank of America. Please go ahead.

Thank you. I guess I'm starting with 2100 Kettner, can you talk about the potential pipeline for that project? Do you think it's the location? Do you think it's the timing? I know it's kind of a new sub-market for you guys, so I want to get some more thoughts.

Hi, Jamie, it's Rob. Let me answer the last part first, which is timing. The project really was ready for tenant improvements in the midst of the pandemic, which didn't help. But that said, toward the end of the pandemic and into this current quarter, we've had continued activity and interest from a variety of tenants, whether it's professional services or technology. I think, because this Little Italy submarket borders downtown San Diego, which has just in general, those two markets have been slower to repopulate that's impacted some of the leasing demand, not only at Kettner, but elsewhere at Diamond View and other projects in Downtown San Diego. All that said, we've made meaningful progress with a very well-known company. I don't want to go further than this comment about it, but we feel like we're making very good progress with them. And more will be shared in the near future.

Okay, thank you. And maybe just I mean, San Francisco.

Jamie.

Sorry go ahead.

Sorry. This is John. The other thing is, and I think I've talked about this before, but originally we thought we would end up with a likely big tenant that we were talking with regarding that property. Their requirements were bigger than what we could deliver. We made the decision to break it up and go multi-tenant, which is kind of the same path we went down when we came on stream or when we were under construction with our One Paseo office space, because we didn't have the pandemic to deal with for those buildings. That's a very similar path. And I'm confident we're going to end up with really very successful rental rates and client base at 2100 Kettner.

Okay. And when do you have to start capitalizing that project assuming you don't have a tenant?

It's going to come into service next quarter, so by next quarter.

Okay. So if it's still there in Q4, you're no longer capitalizing?

Correct.

Okay. And then maybe just to shift gears to CBD San Francisco, I mean, we all see the headlines and then you made some comments, it gets slower. But I mean, can you just give more color on what it's really like just trying to do business there right now? I know you've got a high-quality portfolio. Just any more information on, how you're thinking about how that market is going to look the next six to nine months?

Leasing volume in the second quarter in San Francisco rebounded up to about 1.7 million square feet. I think two notable transactions happened within the last 20 to 25 days. One is Google, taking 295,000 square feet of very high-quality sublease space in Soma. And secondly, Wells Fargo Bank, renewing 661,000 square feet in San Francisco CBD. So those are very notable transactions. Again, you have to separate what the headlines say into the facts about specific submarkets, but I think those are very indicative. The best buildings in San Francisco have an 11.6% vacancy rate, which is much lower than the 20% vacancy rate reported by brokerage firms. So, on the ground how things are feeling as John said, it's sort of up and down. It's not linear. Tuesday, Wednesday, Thursday are very busy. Last week at 101 First where Bill and I are speaking to you today, one of our tenants had a major event for their employees, the elevators and the lobbies were completely full of people. They looked like they were having a really good time. That’s spilled over into Thursday. We’re seeing that not only at 101 First but in other parts of our portfolio. As you know, we’ve said on previous calls or at NAREIT that a lot of this year is going to focus on making, coming back to work fun. So you'll see a lot of effort on bringing teams back together to not only do work but also to promote a fun atmosphere. The last thing I would say is that the streets in the CBD and South of Market and parts of North of Market are in much better shape than they have been. I think that's a function of more people being back in the CBD as well as increased police activity and enforcement.

Okay. And then just going back to the four large expirations next year, can you remind us where they are? And then the one that sounds like could be a move-out. Can you give a small color on that one?

I don’t really want to give more detail. It’s in San Francisco, the smallest of the four that we think may be a move-out. The others are in Southern California, kind of spread throughout the portfolio.

Thank you. The next question is from the line of Brian Spahn with Evercore ISI. You may proceed.

Hi, thanks. Just going back to the Stadium project, John, I was wondering if you could talk to what's given you the confidence in starting this project, just given the economic slowdown and what you're seeing on construction costs and the growing competitive supply pipeline down in Austin?

Yes. I think we have a good plan and we are having a lot of conversations going on with full-floor users, a handful of those are all big names. I think we'll end up on a very good timeline versus where competitors are delivering space, whether those are underway or those that follow assuming they start. That gives us confidence. We have postponed starting the Santa Fe Summit down in San Diego. We've taken a pause on that. We're ready to go whenever we want to push that button. We're entitled and ready to go with 26th Street in Santa Monica. It's a smaller project, maybe a couple hundred thousand square feet. We think Austin is the right location to push forward, and that’s our strategy.

Got it. Okay. And just on the disposition target for the year, Eliott or John, can you talk to your confidence level in hitting that number, where we're at, you haven't done any so far this year? And maybe just more broadly, what interest are you seeing in the transaction market today for office product?

You want to take that Eliott?

Yes, sure. So I think kind of breaking it down into pieces: we are in the market with various transactions. We are adjusting the timing of them. In terms of the confidence level, we’re approaching it as if we see a market that we like and know there’s enough depth to it that we think we can execute at prices that are commensurate with where values should be. We’re pretty confident we can get $200 million to $500 million done. But we aren’t going to force the issue if it doesn’t make sense. We’re seeing the market in real-time and evaluating it. Bigger picture, there is still a demand for lots of different types of assets. It's a little stronger for those that are cash buyers. The levered buyers rely more on the debt markets, which are changing daily.

Thank you. The next question is from the line of Michael Griffin with Citi. You may proceed.

Hey, thanks for taking the question. Just wanted to go back to the 26th Street redevelopment, adding it into the pool this quarter sort of kind of what drove that and sort of what are expectations for that going forward?

For the start of it, the construction?

Yes.

Yes. Well, the LA market the West LA market is cleaning up pretty nicely. You just have to make decisions from a capital allocation standpoint. I feel like this is a similar context to when we had the exchange of construction, which was three-quarters of a million square feet in South San Francisco. We’d be looking to start that. And I think we had Dexter, which was roughly 700,000 feet up in Seattle under construction. We didn't have either lease. And we were asked if we would start a 100 Hooper, and my point was, we would only start it if we had a tenant for it, or if we made significant leasing at the exchange. So looking at it from a company standpoint, we've got KOP. We’re confident we’re going to lease that up but that's a big project at roughly 900,000 feet. We've got Kettner down in San Diego. We're starting the Stadium. We’ve delayed the Santa Fe Summit. We’re going to delay the project you inquired about, 26th Street, and they'll come on stream. We will start at some point. We just don’t feel compelled to start anything right now. Our balance sheet is in great shape. We're not a merchant builder that needs to build just to get fees. We want to see the market continue to improve. We will pull the trigger when we think it makes sense, both with regard to that specific project and in looking at the company in its total context.

Thanks for that. Appreciate the color on it. And then, John, just coming back to what you mentioned in your prepared remarks about the political winds shifting in a lot of your markets with the recall of the District Attorney in San Francisco and the runoff for mayor in Los Angeles coming up. I'm curious if you believe that this will be a big driving factor to people feeling more comfortable coming back in the office, or do you think that it's too quick a shift and then it might take longer to play out?

I think it's a major component of the solution. I mean, there are many factors at play. People are fed up with homelessness and lawlessness. I was looking at statistics that were compiled recently, and while I might be off by 10 percentage points on any number, directionally, murder is up in every major city this year. Violent crime is up significantly in every major city. Car theft is up in every major city too. Many cities don’t even deal with thefts below $1,000. Those statistics are concerning. People are frustrated with all this. In San Francisco, you might cut out the four Republicans who live there, just kidding about that. The reality is that there is broad disenchantment with these issues. Voters are sick of this. They want to clean up the streets. For companies seeing streets starting to clean up, it's a major part of the equation. It's not the only thing, of course, there is the whole work-from-home situation. But I believe this factor is having an impact and companies are very encouraged to see that change moving forward. It's not going to happen overnight but it's a huge first step. A lot of work remains to be done but it feels like we are starting to make progress.

The next question is from the line of Blaine Heck with Wells Fargo.

Great. Thanks. Good morning up there. I was hoping you guys could give us an update on the mark-to-market at each of your markets and whether you've seen any change in our metric recently, especially in Los Angeles where you have a pretty large proportion of your expirations in the next several years?

Hey, Blaine, this is Eliott. I can handle that. No material change in our mark-to-market from what we've talked about previously. It ranges on the West Coast between 10% and 20% by market, in Austin, it’s 30% mark-to-market and kind of blends in that 10% to 15% range.

Okay. Great. Second question is, it sounds like the beat this quarter was largely due to early revenue recognition at 333 Dexter, and we looked back and saw the revenue recognition on developments has been earlier than guidance four times in the last two or three years. Obviously, this has a positive impact on actuals versus guidance, which is great, but I’m wondering if there's anything specific going on that’s enabling you guys to consistently beat your expectations for the timing of revenue recognition on developments, or is that just a matter of staying conservative on guidance and building in a bit of a cushion for tenant move-in?

Yes, please continue, Eliott. I would like to make a comment afterwards.

Yes. We explain the timing of revenue recognition because there is a lot of complexity involved. We attempt to forecast when tenant improvements will be made and when we can recognize revenue, but it's not an exact science. We have been fortunate to exceed our expectations in recent cases. However, this does not guarantee that we will do so in the future, but we will do our best.

Yes, and I make this comment. Justin Smart, our EVP, or now President of Construction and Development at Kilroy, and his team; they're exceptional. They really work with the tenants along with the rest of our deal-making team to move things along and make things easier for tenants to decide. I hope we can maintain the same level of success as we've had in the past, but we'll see. Some companies are experimenting more with the way they’re using space, so they might be slower in moving forward with improvements as they determine whether their mix is the right one or should they trial a design before committing. So things could fluctuate.

Thank you. The next question comes from the line of Vikram Malhotra from Mizuho. You may proceed.

Hi thanks for taking the question. Sorry if I missed this, I just wanted to get some more color on your thoughts around capital deployment. You mentioned the higher bar for assets. Can you maybe give a bit more specifics on what you're changing in underwriting or what you're looking for? And given the quality divide that you highlighted, any thoughts on where the value differential is for say high-quality A-grade office versus the average product?

Yes. Those are good questions. The fact is that as people are utilizing space differently now, there is probably an increased element of scrutiny towards buildings. I’ve always said, the buildings have a physicality that matters to modern tenants. You may need to improve things, but do they have the right dimensions and characteristics? This probably raises the threshold of what is acceptable physically. It doesn’t make sense to buy stuff today in the hopes of big rent increases over the next several years, which we’ve experienced in many of our markets in recent years. In periods like this, it could be that we don’t see the level of rent increases, so your underwriting is going to be more conservative. We look at what would happen if we were to sell the assets, considering the pool of buyers. The flight to quality is not just a tenant-based phenomenon; it's an investor-based phenomenon as well. Sophisticated investors are looking to invest capital in assets that can perform well for many decades. Much of the existing stock doesn’t have that, so the bar is higher in terms of demand, underwriting, rental increases, and building quality. Regarding development, we generally get to develop what we want and we’re quite good at it, but we will also consider construction costs, which vary dramatically between our markets. Everything we have in construction from a development standpoint has a guaranteed maximum price with the contractor. We're comfortable with that same strategy for major tenant improvement work. For example, at the Stadium Tower project that we want to build out at the Domain in Austin, we have that guarantee in place. In other areas we had that for Santa Fe Summit, but we chose to slow down and not proceed with it right now. In Seattle, construction costs have been among the highest in the country due to all the construction work by Amazon and others in the area. For us, it makes no sense to start a building at an all-time peak in construction and labor costs. We think those will moderate, so we’ll look at timing based on visible demand and how those costs evolve. There’s a lot to consider, and with our capital allocation, we don’t want to sell stock or take on a lot of debt, so our likelihood for acquisitions and development going forward is also diminished.

That's helpful. And then just talking about timing, you highlighted the robust demand still for quality life sciences. The two big users or two big opportunities I think you referenced. Just thinking about the opportunities in life science in the Sunbelt, you clearly made the push there in Austin. I'm just wondering if there are specific life science-oriented opportunities that you can share with us?

No. I say that because we don’t have any in the pipeline right now. Life science while there’s tremendous cancer research and activity down in Houston and elsewhere in Texas, is an emerging area in much of the South. There’s a lot of activity in North Carolina, but we’re not down there. So we don’t have any immediate plans for life science projects in those markets, though I could see potential for the future.

Thank you. There are no additional questions at this time. I will pass it back to the management team for closing remarks.

Thank you very much for joining us and for your interest in Kilroy.

That concludes today's conference call. Thank you. You may disconnect your lines.