Kilroy Realty Corp Q3 FY2023 Earnings Call

Good afternoon. Thank you for joining the KRC third quarter 2023 Earnings Conference Call. My name is Victoria, and I will be your moderator today. I would now like to hand the call over to your host, Bill Hutcheson, Senior Vice President of Investor Relations and Capital Markets at KRC. Thank you. You may proceed, Bill.

Thank you, Victoria. Good morning, everyone. Thanks for joining us. On the call with me today are John Kilroy, Chairman and CEO; Justin Smart, our President; Rob Paratte, Chief Leasing Officer; and Eliott Trencher, our CIO and CFO. At the outset, I need to say that some of the information we will be discussing during this call is forward-looking in nature. Please refer to our supplemental package for a statement regarding the forward-looking information on this call and in the supplemental. Our call is being telecast live on our website and will be available for replay for the next 8 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 our third-quarter highlights. Justin will review our in-process development pipeline. And Eliott will discuss our financial results and provide you with updated guidance. Then we'll be happy to take your questions. John?

Thanks, Bill. Hello, everybody, and thank you for joining us today. Over the last several months, we have seen the long-term outlook for the office business improve. More companies are committing to and enforcing in-person work. As a result of higher physical occupancy levels, increased foot traffic and commuter activity, studies are heading towards recovery. For example, New York City has been a leader in this regard as large corporations assist their employees return to the office. This has not only positively impacted physical occupancy levels, but has also restored a sense of urgency and vibrancy back to the city, and I should say, energy and vibrancy. The West Coast markets and the tech companies that dominate them have followed suit, and we anticipate the West Coast will follow a similar trend. San Diego, which was the first mover amongst our markets, is a prime example of how high physical occupancy translates to leasing activity. Over the course of this year, physical occupancy in San Diego has gone up 20 percentage points and now sits above 80%. The region is 89% leased with our primary cluster in Del Mar being 97% leased. Leasing activity in San Diego is amongst the best of any of our regions because higher physical occupancy is translating into tenant demand for space. It's important to note that the green shoots of increased demand are coming in the form of better tour velocity and leasing interest. In times like these, having the newest, most modern assets in the best locations is critical to attracting tenants at the top of the market rent. Additionally, in many of the cities in which we operate, things are beginning to change for the better from a policy perspective. Specifically, recent data points in San Francisco demonstrate there is self-awareness around the challenges the city is facing, and policymakers and voters are taking steps to correct the issues. A few notable examples include District Attorney Jenkins' reelection, which reflects an endorsement from voters of a law and order philosophy. The city is hiring more police officers and increasing their pay. The Board of Supervisors approved delays to payroll tax increases and provided discounts for new businesses relocating to the city. We have much more work to do, but the train is finally moving in the right direction. Shifting to the economy, the labor market remains tight, and inflation, while lower, is not yet at target levels. The market suggests that we are likely to be in a higher rate environment for longer. Any certainty on the trajectory of rates will take time but ultimately will be good for the capital markets even if things stabilize at current levels. However, from a commercial real estate perspective, the same concerns persist: higher rates are putting near-term pressure on real estate valuations as loans originated in a low rate environment come due and need to be refinanced. This dynamic, coupled with a pullback in bank lending following the regional banking crisis earlier this year, has created softer conditions in the transaction markets. We acknowledge there will be continued stress and refinancing risk in our sector. However, we believe we are well positioned against these headwinds. As we talked about last quarter, we closed on a $375 million 11-year mortgage for a portion of our One Paseo campus in San Diego. The loan has a fixed interest rate of 5.9%, and the additional liquidity enhances our financial strength and flexibility in this volatile market. The One Paseo campus continues to perform incredibly well, with occupancy approximately 95% across the entire project, and we have market-leading rents on the office, residential, and retail side. Real estate always goes through cycles. I've been through six myself. We don't know when the headwinds will come or how long they will last, which is why we prioritize keeping Kilroy well capitalized with robust platform liquidity and conservative leverage. As a result, we can stay patient and make prudent capital allocation decisions when we have conviction. With this in mind and given where financing markets are today, we do not anticipate any asset sales for the balance of the year. While markets and sentiment change based on our position in the cycle, the three pillars of our strategy have stayed constant: high-quality properties, strategic capital allocation, and a fortress balance sheet. This simple approach allows us to play offense in the good times and defense in the challenging times. We believe there will be opportunities in the future, and we are taking steps to ensure that we are ready when the time comes. As of now, our goal remains the same: own and operate the highest quality portfolio of mixed-use office and life science properties, clustered in innovative and supply-constrained markets. Turning to the third-quarter highlights, it has been a period of continued volatility. I'm happy to report that Kilroy continues to execute. We signed a total of 188,000 square feet of leases during the quarter, as well as 117,000 square feet of leases post-quarter end. We remain busy and are encouraged by the leasing momentum that we are building across our markets and expect to secure more wins on the leasing front during the balance of this year. In many of our markets, we're seeing a significant increase in demand. At the platform level, just as we have done in prior down cycles, we will continue to be opportunistic in sourcing efficient capital as needed, and we are laser-focused on making the right capital allocation decisions. Lastly, on a personal note, this earnings call marks my 107th quarterly earnings as CEO. We have had 108, which includes today as a public company, but I did miss one in 2007 due to a lack of wind competing in the Transpac sailing race from Los Angeles to Hawaii. Reflecting on my time spanning more than 50 years in the real estate industry and almost three decades with Kilroy as a public company, we have accomplished quite a bit, including a total transformation of our company coming out of the great financial crisis. As I look at the company today, I am proud of our tremendous team. We've never been better positioned from an asset quality, tenant base, and balance sheet perspective. I want to thank every one of you for your support over the years. I am confident that Kilroy will continue to thrive, adeptly handle whatever challenges come next, and outperform in the years to come. With respect to our search for the next CEO, we are entering the home stretch. We have been pleased but not surprised to see that the opportunity at Kilroy has attracted many qualified candidates, both internal and external, and we expect to have an announcement before the end of this year. That completes my remarks. Now Justin will go through our development pipeline.

Thank you, John. At the end of the third quarter, our in-process development totaled approximately $1.7 billion, down slightly from last quarter due to the delivery of 9514 Town Center Drive in San Diego, which is 100% leased to an investment-grade credit tenant. There's roughly $490 million left to fund in the development pipeline, most of which is for the second phase of our Kilroy Point Life Science development in South San Francisco. As you may recall, KOP Phase 2 includes three buildings, and we anticipate they will stabilize in 2025. Indeed Tower, the only other project in our active pipeline, remains on track for stabilization in the fourth quarter of this year and is 74% leased. Regarding our future pipeline, we continue to advance entitlements and design on all projects. As a reminder, the future pipeline consists of eight projects, diversified across five markets and includes a mixture of life science, office, and residential. Similar to prior cycles, we will only start a new project when market conditions are favorable and currently have no plans to break ground on anything in the near term. On a related note, new starts remain minimal, both nationally and in our markets. There are several drivers for this, including reduced pre-leasing demand and expensive financing. We anticipate the depressed supply will provide a tailwind for us as a disproportionate amount of the demand continues to favor young, high-quality space. Our development pipeline, with significant entitlements in place, will provide a competitive advantage for Kilroy as the market improves. With that, I'll turn the call over to Eliott.

Thanks, Justin. FFO was $1.12 per share in the third quarter, a $0.07 decline from last quarter. The difference is predominantly due to lower NOI from the previously disclosed Pac-12 and Amazon move-out and higher G&A from executive retirement costs. On a same-store basis, third-quarter cash NOI was roughly flat as the burn-off of free rent was offset by a decline in occupancy. GAAP same-store NOI was down roughly 5%. At the end of the quarter, our stabilized portfolio was approximately 86% occupied and 88% leased. The decrease from the prior quarter was due to the previously discussed move-outs. Our net debt to third-quarter annualized EBITDA multiple was in the low 6s. Liquidity remains robust, with roughly $1.9 billion in total capacity comprised of $1.1 billion from our line of credit and $790 million of cash and marketable securities. In total, our available cash is sufficient to cover the majority of our near-term development spend and address our next bond maturity in December 2024. During the quarter, we repurchased roughly $6 million of our December 2024 bonds at a discount, thereby reducing that maturity to roughly $410 million. One modeling note, we drew down the last $170 million from our term loan at the end of the quarter. Therefore, the third-quarter interest expense needs to be adjusted if you are trying to use it as a starting point for the fourth-quarter estimates. Now let's discuss our 2023 guidance. As always, no acquisitions are forecasted and, as John mentioned, we do not anticipate any dispositions this year. Development spend for the fourth quarter is expected to be $100 million to $150 million. When factoring in the roughly $3 million of spend year-to-date, the full-year estimate is now $400 million to $450 million, down $25 million from last quarter. With respect to G&A, we continue to track towards the midpoint of our range, inclusive of the previously discussed executive retirement costs. We are tightening the range for our full-year average occupancy percentage to 87% to 87.5%, with no change to the 87.25% midpoint. As a reminder, the fourth-quarter occupancy will include Indeed Tower. Cash same-store NOI is now projected to be between 2.75% and 3.25%, a 100 basis point increase at the midpoint due to better-than-anticipated parking income and some nonrecurring revenue. In summary, our prior 2023 FFO guidance was $4.43 to $4.53 with a midpoint of $4.48 per share. Based on our performance to date, we are adjusting and tightening the range to between $4.55 and $4.60. The new midpoint of approximately $4.58 represents a roughly 2% increase from the prior guidance. The biggest drivers behind the increase are better parking income, earlier revenue recognition on a few leases in the operating portfolio, higher interest income, and the adjustment to our disposition guidance. To provide further clarity, our updated midpoint implies a fourth-quarter FFO of roughly $1.05 per share or $0.07 lower than the third quarter. To bridge the gap, we back out $0.03 due to lower occupancy, which factors in our move-outs and move-ins, and $0.04 for various other items, including higher interest expense. This completes my remarks. Now we will be happy to take your questions. Victoria?

Our first question comes from the line of Nick Yulico with Scotiabank.

I was hoping you could just start, maybe, Rob, with some commentary on where you're seeing more strengths in terms of leasing in the portfolio, types of tenants, size requirements, markets versus where things are a little bit more challenging, which I assume is more on the large tenant side?

Sure, Nick. Let me share some general observations about the leasing environment across our regions and nationwide. Tenants are currently preferring market-ready spaces; shell condition spaces are becoming less appealing and are more challenging to lease. There is also a trend towards flexibility, with tenants looking for lease terms of 1 to 3 years in some situations, while in others, we see terms extending up to 10 years, although the average is around 5 years. We continue to see a flight to quality, which is beneficial for our portfolio. In every market, the best sublease spaces, particularly those with technology-driven build-outs, are moving quickly, and we’re beginning to see these spaces get filled. Notably, Q3 leasing activity is typically lower due to summer vacations, making it harder to finalize deals. However, when comparing Q3 to our quick progress in Q4, it aligns with what John mentioned regarding leasing velocity. Regarding specific markets, San Francisco stands out significantly. There has been a surge in demand, especially since Q1 of '23, where we recorded about 2.5 million square feet of demand, which has now more than doubled to approximately 5.5 million, largely driven by developments in artificial intelligence. Although Q3 leasing volume was lower than anticipated, we have 680,000 square feet in transactions nearing completion with two major AI companies that are expected to finalize in Q4. Therefore, combining Q4 activity and ongoing market trends, San Francisco might achieve around 1.2 million square feet of leasing activity in Q4, matching pre-pandemic averages. Venture capital funding in the Bay Area has reached about $27 billion this year, positioning us well to potentially match the $34 billion total from 2019. In Seattle and Bellevue, there's a distinction between the two markets. Seattle holds promise with the AI movement since it has the second-largest concentration of AI talent in the nation, but this hasn't translated into significant demand yet. In contrast, Bellevue is thriving, especially with gaming companies showing substantial interest, with two large requirements exceeding 400,000 square feet, indicating growth that is mostly driven by new development rather than sublease space. Los Angeles presents a more fragmented landscape, where we’ve completed 35 transactions totaling 359,000 square feet this year. Of these, 22 were renewals covering around 175,000 square feet, with 13 new leases totaling about 120,000 square feet. This highlights an underreported level of leasing activity. Additionally, we're pleased to announce a new 15,000 square foot lease with the MLS San Diego soccer franchise at 2100 Kettner, which we believe will boost momentum for further leasing discussions and prospects. In Austin, while I won't delve into specifics, we are actively engaged in transactions and negotiations. Lastly, regarding life sciences in South San Francisco, while demand hasn't yet reached our goals, it is on an upward trend, with recent VC funding rounds reigniting interest. Notably, one large tenant has removed 100,000 square feet of sublease space from the market, which we view as a positive sign for future developments.

Very helpful. I have a second question about Games. Can you provide any updates on the November expiration? It seems that based on what you mentioned earlier this year, the tenant was also looking at the 2024 expiration. I believe they have already secured some additional space in West L.A. Any insights you could share on that?

Sure. It will be downsizing in terms of their '23 expiration. On the flip side, we're in discussions with them on a variety of scenarios for '24. I just can't go into more detail on that, but we know they're looking at this as a downsize.

So they, in total, the expiration is about 160,000. We expect that over 100,000 will be given back.

Just wondering if you can dig into the life science comments a bit more, just give us a bit more color on prospects at KOP. Some of your peers in that region have said demand has doubled since April, and they're signing leases. So I'm just sort of wondering if you can give us more details on the types of activity or interest you're seeing? And just how should we think about timing and rents?

Okay, Vikram. So rents for new development have maintained at the rate they've been at. There hasn't been any erosion. There is sublease space in the market, and like any office or life science, the sublease space that's high quality will move, and we've seen some of that happen. Other sublease space that's not high quality will remain on the market. As you may recall, we made a decision about a year ago to multi-tenant one of the three buildings at KOP and we expect to have that complete by May of next year. In that multi-tenant scenario, by doing that, we actually increased the amount of activity that we've been seeing because now we're able to talk to tenants about 40,000 feet, which would be one of our floors. The key component of that multi-tenant scenario that I just described is that we're delivering as lab specs. So it's basically ready to move in, and that's also a first-to-market phenomenon that tenants really want. This has helped our tour activity. There still are bigger requirements out there. They're just, as I said earlier, taking longer to get done in this environment. I'd say, generally, the geopolitical environment doesn't help. It seems to ebb and flow, but right now it's not great. So that does slow things down, but we haven't seen requirements taken off the market that have been in the market for the last six weeks or so.

This is John, Vikram. We're looking at everything. We always do. We always have even some things that we know are not particularly of interest, just to make sure that we're reading the market correctly. And that helps inform us when it's time to make decisions. I don’t believe right now we’re seeing anything that - we’re seeing some things we like in various - in all of our markets in terms of quality and location. We're not seeing the pricing that we would like yet. And whether we’ll get there or not, I don’t know. As loans get closer to becoming due and refinancing becomes a reality that people must go through, if they have low interest rate debt that can’t be replaced with regard to the rate or with regard to the size of the loan, I think we’ll see some opportunities loosen up. So we’re going to remain very agile. There is no pressure on us with regard to having to do anything, and we are going to behave like we did back in 2010. It will be a little different, but when we see things we like, we’ll act with conviction. But it’s not yet. It’s not appropriate right now, in our view, given so much volatility globally and in our industry.

John, just a follow-up on that last question and answer. You mentioned how pricing hasn't gotten to the level that's kind of attractive to you guys yet. Can you give us any sense of how far off that pricing is to where it might be interesting? Is it 10%, 25%? And then just generally, how have your targeted returns changed with the increase in rates?

Well, there are buildings that are being sold at what appears to be good prices. When you look at the base number per square foot, but when you look at the repositioning cost and the retenant improvement costs and so forth, it gets up to a pretty high number. So in terms of where things have to move, I'm not going to go there, Blaine, because it's asset dependent for sure. All assets have benefits and flaws. Many of the things that are being traded or to have more flaws and benefits in our opinion. And obviously, we've got to feel comfortable that we're buying into a market that we think is going to be improving, not going sideways. What was the second question? Forgive me.

Just how your returns targets have changed with the increase in rates and what you guys are looking for as far as IRRs?

Yes. I'm not really going to go down that route right now because we're not really looking at buying anything. And it's again, it's going to be obviously north of where it's been. If you look at sort of what we've developed over the last 10, 12 years, we've sort of averaged around 8% going-in returns for brand-new product with built-in significant increases, and that's on an unleveraged basis. So that's sort of where we were which was beating the market. If we're going to buy something, we're going to want to feel very comfortable that we've got a best-in-class asset or we can make it such. Then we're going to end up with a strong double-digit return. So that's what our thinking is right now.

Yes, Blaine, we obviously look at everything. Our priority right now is to, one, make sure the development is fully funded; and two, make sure the balance sheet is in tip-top shape. We do not have interest in repurchasing shares at the expense of leverage. I don't think that's a good trade-off. So we're going to continue to evaluate it, but that's sort of where we stand today.

Maybe regarding the CEO transition, John. I know there's only so much you can say, but I guess at a high level, can you describe how much thought is being given to finding or interviewing qualified external candidates? And how the process is set up to reduce any potential maybe bias of selecting an internal candidate over a qualified external candidate that maybe doesn't have the same tight current relationship with yourself or the Board?

Yes. I can't, as you know, speak very much about that, but there is no bias whatsoever. We sought out, as we, I think, communicated pretty clearly that we are opening up to the outside and inside, and there are strong candidates from both camps. With regard to the outside, there is no bias against that with regard to the process. We're sort of entering the home stretch. Our hope is to be able to make an announcement by year-end. It's been a vigorous process. The whole board has been very engaged in it, and that's about what I can tell you.

Okay. Got it. And maybe you guys had a large tenant move-out in the quarter at 3603rd Street. And now there's some vacancy in the San Francisco CBD larger than it was. So could you talk maybe some more detail on what exactly you're seeing in San Francisco from a leasing activity perspective?

Yes, absolutely. As I mentioned, demand in San Francisco has more than doubled, leading to an increase in tours across our portfolio. We're currently refreshing three of our assets by upgrading lobbies and amenities to stay ahead of this rising demand. Our goal is for tenants to come in and notice the improvements, especially given the competitive landscape. We are in a strong position with our balance sheet, allowing us to selectively choose our business partners. Some of our competitors might be quite eager to fill space, while we can afford to wait for the right tenant and let opportunities go to sublease. Presently, there is about 800,000 square feet of demand for AI in the San Francisco market. Interestingly, whereas I previously noted that the average tenant size was 5,000 square feet, it has now increased to 15,000 square feet, effectively tripling. Our portfolio is experiencing a blend of AI interest along with considerable activity from law firms and some professional services in San Francisco. However, I must caution that there is still a considerable amount of space available in the market, with varying quality. Overall, we believe the trend is positive, but it will take time to navigate through the current situation.

Just wanted to touch on retention briefly. I know it increased quarter-over-quarter. I'm wondering if we should consider the current rate of retention as how it relates to kind of a go-forward basis to a 40% or so level — how we should think about it?

So, Michael, this is Eliott. Historically, we've sort of been in that 50-ish percent range, plus or minus. This year, we've been a little bit lower. Earlier in the year, I said it was a little better. This quarter, it's going to be very choppy. In particular, in '23, it was very choppy given some of the larger move-outs that we discussed. We think overtime our long-term trend is sort of the right number where we'll ultimately settle.

Yes, I'm going to double-team this. I'm going to ask Rob to jump in for the second part of that question. Return to the office has been fundamentally important; it's foundationally important to office, obviously. We've all had our concerns over the last couple of years, and rightfully so. Some companies are very vigorously enforcing. Others are increasing their enforcement. There are some companies that are — very few — that are saying you can still work from home. There are very, very few in that category. There’s been a little resistance some, as we've said over the course of this year; as the economy has deteriorated, it's likely that people are going to get out of their homes and back into the office or find that they're permanently in their homes and no longer employed, and that's happened. So more to come on that. But in terms of what we're seeing in our buildings in our cities, there have been significant increases in activity. We've talked about in previous calls how the public transportation systems have had significant increases in volume. Our parking garage has a significant increase in volume. We're seeing the utilization rates in our buildings significantly increase. And Rob, I'm going to pitch that to you to add a little bit more color on that aspect.

Sure. And Michael, we're going to triple team this because Eliott will take part of this, too. But to add on to what John said, he's absolutely right. With the companies that we're talking to, most, if not all of them, have factored into their performance reviews physical presence in the office. That results in your pay being affected if you're not coming to the office. That's sort of across the board with the tech companies that we deal with. That's the kind of meat they're putting into it. I think some of the others, I won't name names, but some of the others have basically said if you're not in, you're not working here. So it definitely is forceful, and it's definitely — if you use San Francisco again as a proxy, as John said, parking revenues are up, the streets are busy now; Monday through Thursday, Fridays are lighter, but it's busy most of the day throughout the day in the financial district. I'll let Eliott.

In terms of our portfolio, we have a range across our markets. The Bay Area is sort of in the 40s, which is the lower end of our spectrum, and as we talked about, San Diego is at the high end of our spectrum, over 80%.

Just following up on that last question since there's still a lot of skepticism around the return to office mandates. Like you pointed out, there’s evidence of this through your parking revenue. Can you elaborate on what assumptions are built into your Q4? Has guidance been updated to reflect the run rate of how parking has outperformed your budget? Or is it still based on your initial projection set up at the beginning of the year?

Yes. So Camille, this is Eliott. We're sort of somewhere in between. We obviously have three quarters of evidence, so we have a little bit more conviction on where things are going, but there's always some uncertainty and some seasonality to it also. Right now, we're kind of in between where we were at the beginning of the year and our third-quarter run rate. Sure. That's a function of the capital that we raised during the quarter, both the One Paseo secured loan and then the $170 million term loan. Some of that cash we had invested in short-term CDs. The way the accounting rules work, if there's anything over three months, it gets classified as a marketable security. That's what is in that number.

I was wondering if you could provide a little bit of color just on any known move-outs in '24. I understand you mentioned retention will be choppy, but do you have any known move-outs in '24 that you've highlighted?

So Jay, this is Eliott, Rob and I will tag team this. Only two expirations next year, over 100,000, one in the Bay Area, one in Seattle. As far as the.

We're making progress on that. We have some transactions in the works and expect more to come.

Okay. And then just one other quick question. Indeed Tower is 74% leased, but the occupancy is lower at 60%. Is it being added to the operating portfolio in the fourth quarter? Do you expect that gap to narrow in the fourth quarter? Or would you expect that same occupancy-to-lease percentage gap to persist?

It's going to persist until the move-ins fully occur, which is going to take time. So anticipate we'll be closer to the occupancy and then the occupancy and the percentage lease will merge, but that will be mainly over 2024.

So highlighted a few moving pieces around Games, Indeed Tower and some of the move-outs to '24. Do you feel that 4Q will likely be sort of the floor occupancy, and maybe you can start to begin to grow in '24?

This is Eliott. We're certainly not going to give 2024 guidance at this point. What we can say is that as we look at the backdrop for 2024 as compared to 2023, in '23, we had about 1.5 million expiring going into the year, five companies, 100,000 or larger, which actually comprised two-thirds of that 1.5 million. Going into next year, we have about 1 million square feet expiring. As we said, there are two tenants over 100,000. They are closer to about 30% of the total. We anticipate it being much less binary in 2024 versus 2023. If we want to look at 2025, it's about 700,000 expiring with no tenants above 100,000. Again, I can't say how everything plays out, but it should be less binary. Yes, so it's a function of a few different things. One: as we came into the year, we gave a range that had zero at the low end, in part because we sort of knew that the market was a little tough to project. We had no interest in playing into a weak market as a seller. Two: we did not project raising 375 million via the One Paseo mortgage in the beginning of the year. But from a liquidity perspective, we had done much better than we anticipated. Because of that and because of the financing dynamics that John discussed, we didn't anticipate seeing much interest at pricing that we deemed acceptable. That's why we decided not to pursue anything. Generically speaking, the capital that seems to be out there in the greatest forest is opportunistic capital. You can see that by some of the properties that have traded at pretty low per square foot numbers. Now as we evaluate that, we don't think the quality is commensurate with our portfolio, which is why we don't pursue it. That kind of plays into the decision we just talked about.

Yes, I have nothing to further add. I think that's a good summary.

I guess just going back to your comments; I appreciate you're not going to comment on how far pricing has to fall for you guys to get interested in deploying capital. But are there certain markets where you're sort of getting closer or more eager to deploying capital than others, given where pricing is?

Well, yes, we're not getting closer to deploying capital, but there are signs of a few buildings that we like at pricing that would make sense and that qualitatively meet our desires. I'm not going to tell you which markets because I don't feel that we, from a competitive standpoint, want to let other competitors know what we're thinking. But you should — I'm going to say what I said in Arizona NAREIT in 2009, and that was you'll see us in many different markets, in this case, the markets that we're already in looking. When we think the time is right, we will strike. We don't think the time is right yet. But there are some assets that are in need of being recapitalized. So we'll play our cards very carefully, and we're over it.

Could you just talk a little bit about discussions for the rest of the space and Indeed Tower and specifically new supply in Austin and how that's potentially impacting those discussions?

Sure. This is Rob. I’m just gathering my thoughts. Some of the new supply in the market consists of sublease space. One observation is that we’ve seen a significant amount of sublease space removed from the market by tenants in the last quarter. So, the situation in Austin is currently changing. Additionally, another tech company recently acquired 100,000 square feet because they underestimated their headcount and space requirements. The market is quite dynamic right now. We have activity, and we are the best building in the CBD, without a doubt, attracting any tenant exploring options. Our interest spans a variety of sectors, including financial services, law firms, and technology. However, I won’t disclose specific transactions or our current status with letters of intent or leases. We’ll have more updates to share soon.

This is John discussing Austin, Indeed, and the marketplace overall. I visited Austin two weeks ago with our local team to evaluate our market positioning among available and upcoming buildings. I'm pleased with our quality, location, and availability. However, some buildings being constructed in puzzling locations likely won't perform well. There are buildings that have tried to compete with us, and we've never lost a deal to them. Our success isn't guaranteed; we put in the effort. I believe we are in a strong position regarding the new products coming into the market. We've secured excellent rental rates and terms with high-credit tenants, and we have several tenants we’re collaborating with on projects. I anticipate a strong performance in the coming year.

And one more. I appreciate the comments earlier about return to office. I think you said you're in the 40s and the Bay Area. I was wondering if you could dig in and just talk about how it's returned to office been in the South market submarket in San Francisco, kind of what you're seeing on the ground there? How successful companies are in getting people back to the office in that part of the city?

I'll start off with — yes, Rob, let me just start off on that. As you can tell, we're in different locations. So we have to play a little bit of a delayed phone tag. The office tenant, the big office tenant that's in Phase 1 of KOP, which was the initial 700,000 feet that's fully leased, their occupancy has been very high. They've been hosting in their atrium several hundred people multiple times per week. It's my understanding, mostly AI people, and they're really active in that building as are the folks in the life science portion of that phase. As far as the rest of the market goes, perhaps you could respond to that, Rob?

Sure. Yes. I agree with John. The only thing I would add is that in our Southeast market portfolio, it somewhat depends on companies. But if you look at Adobe or Cruise, they're back to work. Those are both south of market. Our non-tech companies are more back, I guess, than the tech companies, but we're not monitoring company by company. I would say that South market is visibly busier than it was, and it's equivalent to what I was saying about the financial district as a whole. When these two deals that I mentioned earlier happen in the fourth quarter, the 680,000 between two deals, both of those are locating south of market. And there are office...

On your cash and marketable securities, can I just ask what interest rate you're earning on that?

So it depends on the duration, but right now, call it in the 5.

And is there anything in the marketable securities other than the CDs that you mentioned?

No.

Do you foresee — I know you talked about having a high balance for development spend and to retire debt in December of next year. But do you foresee maintaining a high cash balance in the short term just to provide some liquidity for any opportunistic acquisitions?

In the short term, that cash is going to go to effectively fund the development pipeline. So it's reasonable to assume that it gets smaller over subsequent quarters because we're going to continue to fund it.

Okay. My last question is on the termination income that you had this quarter, which is pretty modest. I was wondering if you could provide some color on that and what you're expecting for the remainder of the year.

There's really just one small lease that paid a termination fee in San Francisco for retail space, which is what really drove it. We are not projecting any other termination income for the balance of the year.

There are no additional questions waiting at this time. I would now like to pass the conference over to the management team for further remarks.

Thank you, Victoria, and thank you, everyone, for joining us today. We appreciate your continued interest in Kilroy. Have a good day.

That concludes today's call. Thank you for your participation, and enjoy the rest of your day.