Kilroy Realty Corp Q4 FY2024 Earnings Call

Good afternoon and welcome to the Kilroy Realty Corporation Fourth Quarter 2024 Earnings Conference Call. My name is Harry, and I will be your operator today. All lines are currently in listen-only mode and there will be an opportunity for Q&A after management’s prepared remarks. I would now like to hand the conference over to Doug Bettisworth, Senior Director of Corporate Finance. Thank you. You may proceed.

Good morning, everyone. Thank you for joining us. On the call with me today are Angela Aman, CEO; Jeffrey Kuehling, EVP, CFO and Treasurer; and Eliott Trencher, EVP, CIO. In addition, Justin Smart, President; and Rob Paratte, EVP, Chief Leasing Officer, will be available for Q&A. Please note 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 webcast live on our website and will be available for replay for the next eight days. Our earnings release and supplemental package have been filed on a Form 8-K with the SEC, and both are also available on our website. Angela will start the call with a strategic overview and quarterly highlights, Eliott will provide a transaction market outlook, and Jeffrey will discuss our financial results and provide you with our 2025 guidance. Then we’ll be happy to take your questions. Angela?

Thanks, Doug. I’m pleased to report on a strong end to 2024, which was capped off by outperformance in our financial results and a material acceleration in leasing activity. In addition, throughout the course of last year, this team worked tirelessly to prepare for the recovery we knew would take hold in our markets, making critical senior hires across the platform, rethinking processes and systems to be more efficient and nimble, successfully completing several in-process development and major repositioning projects, and taking significant steps to address our future development pipeline and other non-income producing assets including the sale of our corporate airplane, which closed in the fourth quarter. During the fourth quarter of last year, we signed approximately 708,000 square feet of leases, achieving our highest level of leasing activity since the fourth quarter of 2019, a testament to the ongoing demand for high-quality spaces that align with evolving tenant needs. The quarter was headlined by two significant deals. We executed a multi-floor lease with Walmart at Skyline Tower in Bellevue, Washington. Our regional team worked creatively to accommodate Walmart’s significant requirement and accelerated timeline, simultaneously executing an early termination with an existing tenant for a portion of the space that Walmart will occupy, addressing a late 2025 expiration and achieving a meaningful rent increase in the process. In addition, we executed a 274,000 square foot new lease in the San Francisco Bay Area with a global technology company that is the subtenant occupying our largest 2026 expiration. Over 70% of the square footage for this expiration has now been addressed through the lease signed this quarter and a 157,000 square foot lease signed with the same tenant in the fourth quarter of 2023. This execution combined with the SAP renewal in Bellevue, Washington announced last quarter underscores the proactivity of our team as it relates to addressing our 2026 lease expiration and the increased willingness of tenants to engage and make long-term commitments related to their space needs. Given historically low levels of new supply and increased workplace attendance requirements taking effect, our markets are demonstrating important signs of sustained recovery and we expect these trends to continue to accelerate over the next several years. Kilroy has unique opportunities to capture this growing momentum as we executed over the course of this year. One particular area of focus is the embedded upside inherent in our highest quality vacancies, specifically those concentrated in recently developed or repositioned assets including West8 in Seattle, 2100 Kettner in San Diego and Indeed Tower in Austin. These properties set the standard for quality, functionality and market-leading amenitization, ideally positioning them within their respective markets. Vacant space at these assets alone represented 410 basis points of leased occupancy upside at year end, highlighting an exceptional source of future growth for the company. And while not reflected in our occupancy statistics until early 2026, the second phase of Kilroy Oyster Point in South San Francisco will be a substantial growth driver for the company in the coming years. The project received its temporary certificate of occupancy in January 2025 following slight delays in municipal approvals and is now fully ready to welcome tenants. The spec suites, conference facilities, food and beverage offerings, and outdoor meeting and event spaces set this project apart from competitive supply in the market and are driving constructive conversations with several life science and office users. While the environment in South San Francisco remains highly competitive, we are confident in the quality of what we’re delivering in Oyster Point and the long-term success of this project. In conclusion, our fourth quarter and full year results, including our robust leasing volume, speak to the strength we see emerging across our markets and the Kilroy team has prepared for a busy year across every part of our platform. I want to thank the team again for their hard work and dedication in 2024 and for the energy and enthusiasm they are bringing to 2025. Eliott?

Thanks, Angela. The transaction market closed the year on a positive trajectory. Deal volume and financing levels were higher year-over-year with a bias towards smaller deals. In 2024, approximately 85% of office sales were under $100 million. By comparison, this number was 70% of transactions back in 2019. Another sign of progress has been the return of core capital to the sector. In the fourth quarter there were notable core deals in Austin and the Bay Area with going-in yields in the mid-6% to low-7% range. The combination of deeper bidding pools and a variety of capital sources is encouraging us to start testing the sales market again, something we put on hold over the last few years as valuations were in flux. We will focus our disposition efforts on properties where the current market value does not appropriately reflect our assessment of the medium-term risk. Fortunately, our funding needs are modest over the next few years and our balance sheet is in good shape so we will only proceed with sales that meet our stringent criteria. And while we did not acquire anything during the quarter, we remain optimistic about the opportunity set of potential value-creating acquisitions. Turning to land sales, as we mentioned last quarter, we are in advanced discussions with residential developers on two sites in our future development pipeline that are expected to generate in excess of $150 million in proceeds. There remains an acute need for more housing in Southern California and re-entitling commercial land is a logical way to address the significant and growing problem. We expect to have more to discuss on our capital recycling initiatives as the year progresses. Given continued uncertainty in the transaction market and our expectations for an elongated closing process on our land sales, guidance does not contemplate any FFO impacts from such activities and we will continue to update our expectations throughout the year. With that, I will turn the call over to Jeffrey.

Thanks, Eliott. FFO was $1.20 per diluted share in the fourth quarter and it was impacted by several one-time items totaling approximately $0.11 per share including a $6 million gain on the sale of the corporate plane, $4.7 million of GAAP restoration fee income and $2.5 million of GAAP termination fee income. Cash, same-property NOI growth was 70 basis points in the fourth quarter including a 90 basis point contribution related to restoration and termination fee income. Occupancy ended the year at 82.8% and it was impacted by several large move-outs that were discussed on last quarter’s call, including Capital One and Microsoft in the San Francisco Bay Area and a short-term lease expiration in Los Angeles. Now let’s discuss 2025 guidance. Our 2025 FFO guidance range is $3.85 to $4.05 for diluted share representing a midpoint of $3.95. 2025 average occupancy is expected to range between 80% and 82%, a decrease of approximately 300 basis points versus our average occupancy in 2024. The decrease is primarily driven by the previously mentioned fourth quarter 2024 move outs, as well as three larger move outs or downsizes expected to occur in the first quarter of 2025, totaling approximately 216,000 square feet. Following the activity in the first quarter, no remaining expiration in 2025 is in excess of 50,000 square feet. Cash, same-property NOI is projected to decline between negative 1.5% to negative 3%. Despite the average occupancy decline expected during 2025, the limited detraction from base rent highlights the strength of our contractual rent growth across the portfolio. Please note that the same-property NOI growth is expected to be lower in the second half of the year, primarily due to the trajectory of occupancy and significant restoration fee income recognized in the second half of 2024. The combination of G&A and leasing costs totaled just under $81 million last year, a steep decline from approximately $100 million in 2023. During 2024, our focus was on both reducing the total amount of overhead spending and ensuring that each dollar of spending was appropriately allocated across the platform. The $83 million to $85 million overhead guidance we have provided for 2025 represents a more appropriate run rate going forward. Moving to interest income, you may recall that last January we pre-funded our capital needs for 2024, resulting in elevated cash balances for most of the year which were utilized to pay down a portion of our term loan balances and repay $400 million of unsecured notes at maturity in December. We expect to maintain less cash on hand during 2025 and in turn we expect a significant reduction in interest income down from $38 million in 2024 to about $6 million in 2025. We remain committed to methodically evaluating each land parcel to determine its highest and best use and the optimal program for project execution. In conclusion, we remain well positioned to navigate the evolving market landscape with strong liquidity, stable leasing fundamentals and a disciplined capital allocation strategy. With that, we’re happy to take your questions.

Thank you. We will now open the call for your questions. Our first question today will be from Upal Rana with KeyCorp. Please go ahead. Your line is now open.

Great. Thanks for taking my question. You guys laid out several known move outs for 2025, particularly 1Q. I was wondering what your current visibility on occupancy is for 2025. Do you expect to potentially bottom this year?

Yes, I mean, just to talk through a little bit, sort of the dynamic in 2025 that I think Jeffrey did a good job at laying out. We’ve got some significant move outs in the first quarter of the year, which include an 80,000 square foot move out we had talked about previously. In addition to that short-term lease associated with the bankruptcy situation from the fourth quarter that will also be, we believe, significantly downsizing but remaining in the portfolio in Q1. After we get past the first quarter, we do expect a lot more stability in the occupancy level throughout the year. Jeffrey mentioned that after the first quarter, our largest move out or largest expiration, I should say, in 2025 is no greater than 50,000 square feet. So there’s a really granular pool and we will start to really see the benefit, I think, from the leasing activity that’s been done over the last couple of quarters. As we look into 2026, as you can see in the lease expiration schedule, we certainly have a higher move out year in 2026. Our largest expiration in 2026 has been one lease that was just under 600,000 feet. We made some significant headway on that this quarter and have now addressed over 70% of that expiration. So I think we’re making good progress as it relates to 2026. Feel pretty good after we get through the first quarter about how expirations look for the balance of 2025.

Okay, great, that was helpful. And then, on KOP 2, could you give us a sense of what the conversations have been like over the past few months and maybe what your existing pipeline is currently there?

Yes, I’ll just kick it off and then turn it over to Rob for some additional detail. I think what I’d say about this project today is that the completion of the project in January has really sort of changed the nature of the conversations we’re having at that project. We’re seeing that result in additional tour activity and additional constructive conversations across a broad range of tenants and a broad range of sizes. South San Francisco remains a very competitive market and we are pleased with the traction we are seeing post completion.

Sure. Adding on to what Angela said, this is Rob Paratte. Taking a step back and just looking at KOP now that it’s delivered. It is the most notable newly delivered life science project in the most preeminent market on the west coast for life science. We’re seeing a broad swath of interest from tenants as well as brokers from across the Bay Area. That focus runs from life science, to technology companies and financial services, especially from large users. The project has really come into its own, and it’s attracting a lot of attention in a positive way. The leasing environment in the Bay Area is improving for life science. VC funding for 2024 was $11.1 billion, which is up 39% from 2023, and that’s specific to life science. Overall, 2025 is setting itself up to look very positive.

Great. Thanks. Good morning, out there. Angela, I just wanted to come back to your comment about the 2026 lease expirations. You said the largest one was $600,000 and you’ve addressed over 70% of that. Just to be clear, is that reflected within the lease exploration schedule that’s still showing 1.9 million feet? Or has that not maybe taken effect yet?

Yes. That’s a really good question, Steve. That has still showing in the 2026 expiration schedule. We did add some footnotes this quarter to give you a little bit more detail on what of that number, what in the 2025 and 2026 towers have already been addressed. But the reason it’s still showing in the 2026 towers is because it wasn’t a renewal with the existing tenant. It was a direct deal with the subtenant. And so you won’t see that reflected until the new lease takes effect.

Thanks. Can you just talk about the cost for KOP Phase 2 went up a bit this quarter and the stabilization date, I think it was pushed out a quarter. Can you just talk about what drove those?

Yes. The timing was really related to just some slight delays in final municipal approvals. The project did reach full completion in January, and so it’s really just a matter of timing.

Thanks for taking the question. Just wanted to touch on the new leasing pipeline. Obviously, you guys had a very strong quarter in terms of new leasing in 4Q. But as you sort of look at the pipeline today, have you guys been able to sort of backfill or punish the strong amount of activity that you guys did during the quarter?

Yes, I’ll start with the last part first. What’s creating demand is a variety of factors. One is return to office, with a 23% increase in traffic in downtown Seattle in the last 90 days. The sentiment is that things are more stable in terms of predicting the future. The movement you’ve seen in our leasing volume, particularly in new leasing volumes over the last couple of quarters, give us confidence that we’ll continue to see our markets overall continue to accelerate through 2025. I’d say our pipeline today is stronger, we have more LOIs in place, and an LOI has a much higher degree of certainty for closure than proposals.

One thing you really saw come through in the fourth quarter leasing and we’re seeing in the pipeline as we look out into the first quarter as well is just the willingness and ability of tenants to make decisions and to commit to longer-term leases. We think that’s a really healthy dynamic.

Great. Thanks for taking my question. You guys have talked a lot about the versatility of KOP to meet various types of demand. Are you seeing life science companies looking for more traditional office space rather than lab space?

With respect to the office comment, keep in mind that KOP is a purpose-built life science project. Some of the projects we compete with are conversions. So they’re former office buildings that have been converted to life science. The conversations we’re having are roughly a 60/40 split between lab and office on a floor. We can accommodate any mix of lab and office that a tenant would want.

Thank you. And with no further questions on the line at this time, this will conclude the Kilroy Realty Corporation Fourth Quarter 2024 Earnings Conference Call. Thank you for your participation today. You may now disconnect your lines.