Kilroy Realty Corp Q2 FY2025 Earnings Call

Hello, everyone, and a warm welcome to the Kilroy Realty Corporation Second Quarter 2025 Earnings Conference Call. My name is Emily, and I'll be coordinating your call today. I would now like to hand the call over to Doug Bettisworth, Vice President, Corporate Finance. Please go ahead.

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 this information that 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 8 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 an update on our recent transaction activity, and Jeffrey will discuss our financial results and provide you with updated 2025 guidance. Then we'll be happy to take your questions. Angela?

Thanks, Doug, and thank you all for joining today's call. Before we begin, I want to take a moment to acknowledge the tragic events that played out last night in New York City. We're thinking about the victims, their families, and everyone who is directly impacted by the traumatic events as they unfolded. Our hearts go out to everyone impacted. Turning to last night's release. I'm pleased to report on a strong quarter of execution across every discipline within our company, as West Coast office fundamentals continue to solidify. During the quarter, we signed over 400,000 square feet of new and renewal leases, a material improvement both sequentially and year-over-year was a pickup in tenant sentiment and ongoing flight to quality dynamics in the office market uniquely position our premium portfolio to capture accelerating tenant demand. In parallel, we're seeing early indications of an improvement in the transaction environment as buyers and sellers appear more prepared to execute. An encouraging signal that market participants have greater conviction in the continued path of the West Coast office recovery. From a leasing perspective, we saw significant strength this quarter in both San Francisco and San Diego, with the recent inflection in activity in the city of San Francisco being particularly notable. Active tenant demand in the city has nearly doubled since 2023, now totaling approximately 7 million square feet despite a significant increase in recent execution velocity. We appear to be at the tail end of major space givebacks by big tech companies, and the market can now benefit from the substantial growth and expansion of companies in the AI space. In addition, positive trends in public safety and downtown revitalization efforts by the city's new administration have given tenants the confidence to expand their search parameters outside of the financial district and into the South of Market or neighboring submarket, where our assets have seen a 110% year-over-year increase into our activity. A clear example of these dynamics is a 93,000 square foot lease we signed in the second quarter with an AI tenant at our 201 3rd Street asset in SoMa. This large transaction marks the second consecutive quarter of major leasing at this property and underscores the ability of our leasing team to understand the specific needs of rapidly scaling AI tenants, many of whom are actively prioritizing landlords who can accommodate their anticipated growth trajectories and provide flexibility that will allow them to grow incrementally over time. We're excited about the turnaround we're seeing play out in San Francisco and are well positioned to capitalize on the accelerating momentum. In San Diego, which has been a consistently strong market for some time, we experienced broad-based activity in the second quarter across all submarkets. In Delmark Heights, we signed a renewal and expansion at One Paseo at the highest rate ever recorded for an office lease in San Diego County. In Little Italy, we signed a 24,000 square foot lease at our recently developed 2100 Kettner asset, continuing the accretive lease-up of some of the highest quality vacancy in our portfolio. And in UTC, we signed a 25,000 square foot lease at our new executive drive redevelopment projects with a leading research and healthcare institute. As it relates to development leasing at Kilroy Oyster Point, our premier development project in the heart of the South San Francisco life science ecosystem, we're pleased to report that we have advanced to active lease negotiations on multiple transactions totaling approximately 100,000 square feet and we anticipate lease execution with these life science and healthcare tenants during the third and fourth quarters. As we progress deals that have been in the pipeline for some time, we've also continued to see meaningful engagement from new prospects as well. Tour activity during the second quarter accelerated meaningfully and highlights the degree to which the quality and scale of Kilroy Oyster Point continues to resonate with high-caliber growth-oriented tenants taking purpose-built infrastructure in a primary innovation cluster even against the backdrop of a more challenging life science ecosystem. Turning to capital allocation. We'll remain active and disciplined as we recycle capital with a focus on long-term cash flow growth and value creation, being responsive to evolving dynamics in the office and life science sectors and changes in the relative attractiveness of the various submarkets in which we operate. As we look forward, we believe that continued portfolio rotation executed thoughtfully and strategically will be key to unlocking value in today's environment. Our investments team has been very active over the last several quarters, teeing up dispositions and underwriting acquisitions that fit with our long-term objectives. Accordingly, last night, we announced the disposition of an operating property in downtown Santa Monica and the execution of a contract to sell a 4-building campus in Silicon Valley, which is expected to close at the end of the third quarter. These dispositions at attractive valuations have allowed us to efficiently monetize several lower-growth assets that we believe would have required outsized reinvestment capital over the coming years. As proceeds are realized, we'll pursue a balanced mix of selective reinvestment opportunities and debt repayment with a focus on optimizing portfolio returns and maintaining a strong and flexible capital structure. We're pleased to see the pipeline of actionable, value-accretive opportunities in some of the highest-performing submarkets on the West Coast and in Austin continue to grow. And as always, we'll be evaluating such opportunities relative to all of our reinvestment options including leverage-neutral stock buybacks. As it relates to our future development pipeline, we've made further progress on monetizing land parcels that have the highest and best use outside of the company's core competencies. As discussed last quarter, in April, we signed an agreement to sell a portion of our Santa Fe Summit site in San Diego. And last night, we announced an agreement to sell at 26th Street in Los Angeles. These announced transactions, which aggregate total expected gross proceeds of $79 million, represent over half of our stated goal of realizing $150 million from the monetization of the future pipeline, with proceeds to be realized over the next several years as reentitlement efforts are completed. The Flower Mart project, which consists of a 7-acre development site in the central SoMa submarket of San Francisco, remains our single largest investment in the future development pipeline. As discussed on the last several conference calls, long-term value maximization at the Flower Mart will require the creation of significant additional flexibility and optionality as it relates to both the ultimate mix of uses on site and the phasing of development execution. Over the course of the last 6 months, our development team has worked diligently on a significant redesign and reimagining of the Flower Mart project that will allow us to be responsive to market conditions as they continue to evolve. As you may remember, we're currently entitled for a 2.3 million square foot primarily office project. And while we remain very encouraged by the resurgence in office demand in San Francisco, we also remain convicted that maximizing value on the site will require a broader mix of uses than originally contemplated, which may allow for the development of certain components of the project earlier than otherwise anticipated. We have recently had constructive and encouraging conversations with the city regarding our proposed modifications to the program. While these discussions are still ongoing, we've gained greater clarity around both the approval process and the time line required to secure the flexibility we're working towards. As a result, based on the best information we have available today, we expect interest and other expense capitalization at the Flower Mart to cease at the end of 2025. While we will update this assumption as appropriate, we're not currently assuming any capitalization of the project in 2026. I want to conclude by thanking the entire Kilroy team for another outstanding quarter of execution across all fronts. The pace of work has accelerated across the company as leasing and transaction activity has increased, and I'm grateful for the way the entire organization has responded. At the same time, this team's willingness to innovate and embrace change is creating additional value for our stakeholders each and every day and positioning us for continued success in the quarters ahead. Eliott?

Thanks, Angela. Before getting into the specifics on the transactions we announced last night, I want to expand on the long-term objectives of our capital allocation strategy that Angela referenced, highlighting 3 primary goals. First is something we have discussed on prior calls. Monetize non-income-producing land that has a higher and better use beyond office or life science. Second, sell operating properties that are valued at favorable levels relative to our expectations for fundamentals. Third, concentrate investments in areas of conviction, specifically submarkets with diverse and robust demand drivers, high barriers to entry, and a track record of significant and consistent rent growth. These goals have guided our actions to date. And as we continue to execute, we are confident that we will further distinguish the Kilroy portfolio and better position the company for outsized cash flow growth. With that said, we're thrilled to have 2 land sites and 2 operating properties in various stages of completion. In total, these 4 transactions will raise over $480 million of gross proceeds. First, on the land sales. We're under contract to sell at 26th Street in our Los Angeles region to a residential developer for $41 million or roughly $20 million per acre. Similar to our sale of a portion of Santa Fe Summit, 26th Street has a path to residential entitlements that does not require a full change of use. We expect the transaction to close upon receipt of entitlements, which we estimate to be in 2026. Next, at the very end of the quarter, we completed the sale of 501 Santa Monica in Downtown Santa Monica to an institutional owner for $40 million or slightly over $500 per square foot. The building is one of our older properties and requires a substantial amount of capital due to both base building needs and leases rolling over in the coming years. In our view, the capital requirement was outsized compared to the growth prospects for the property, making this a logical disposition candidate. Additionally, we are under contract to sell a 4-building campus in Silicon Valley for $365 million or $550 per square foot. This campus is 89% leased today going down to 65% leased in 2026, when 2 of the 4 buildings will be fully vacant. One of the vacant buildings is 25 years old and requires both base building capital and leasing capital. The other has been leased by a single tenant and requires leasing capital, all of which adds up to a significant spend in a market that has seen pressure on rents in recent years. As we evaluated alternatives, we concluded that selling at this value generated the best risk-adjusted return for shareholders. Finally, touching on acquisitions, we continue to diligently underwrite a variety of deals across all our existing markets. We do not have anything to announce at this time, but the opportunity set has improved in recent months in terms of both quantity and quality. We're optimistic that we will find investments that meet our criteria, generate little to no dilution in the short term, and produce materially better cash flow growth in the medium and long term. With that, I will turn the call over to Jeffrey.

Thanks, Eliott. FFO for the quarter was $1.13 per diluted share, which includes approximately $0.11 per share of one-time items, including most notably, a $10.7 million lease termination fee which contributed $0.05 per share to FFO, net of non-controlling interest. Additional one-time items include approximately $6.9 million or $0.06 per share, largely related to tax reversals and net real estate tax refund benefit. Cash same-property NOI growth in the second quarter was 450 basis points, with the previously mentioned one-time items on a cash basis contributing 300 basis points. Turning to occupancy. We ended the second quarter at 80.8%, down from 81.4% at the end of the first quarter. As previously communicated, this decline was expected and reflects the rightsizing and renewal by DermTech along with the early vacate related to the 23andMe bankruptcy. It's worth noting that the second quarter occupancy statistics now exclude both the 89% leased 4-building campus designated as held for sale in 501 Santa Monica, which was sold during the second quarter. Accordingly, we made conforming updates to our lease expiration schedules to reflect the removal of these assets. While their removal negatively impacted occupancy by 20 basis points, we were able to maintain the midpoint of our occupancy guidance range due to the team's continued success in accelerating lease commencement dates across the portfolio. Looking ahead, we continue to expect a modest decline in occupancy in the third quarter, primarily due to the addition of 2 redevelopment projects entering the stabilized portfolio during the period. That said, we also remain optimistic, as we will see positive net absorption in the fourth quarter, supported by significant lease commencements from previously executed leases. It's important to note that the spread between leased and occupied space increased to 270 basis points this quarter, a 100 basis point improvement year-over-year, representing significant built-in growth that will materialize in the portfolio throughout the second half of 2025 and into 2026. The GAAP re-leasing spreads were negative 11.2% in the second quarter, and cash releasing spreads were negative 15.2%, both of which were largely impacted by a single large lease in San Francisco. While this lease was completed at lower base rents, they require limited capital and produce strong net effective rent. Notably, the lease term, which is under 3 years will provide us with a valuable near-term occupancy while maintaining our ability to reprice the space as the market continues to improve. Excluding this one transaction, cash re-leasing spreads would have been approximately positive 1%, representing a meaningful improvement relative to the prior quarter. Turning to guidance. We raised our 2025 FFO outlook to a range of $4.05 to $4.15 per share, a $0.15 increase at the midpoint. This revised guidance reflects our updated expectations for capitalization of the Flower Mart accounting for $0.08 per share at the midpoint. The significant termination fee recognized in the second quarter, representing $0.05 per share, and our updated same-property NOI guidance, representing $0.04 per share, all of which were partially offset by the anticipated net impact of announced capital recycling activities. Same-property NOI growth is now expected to range from negative 1% to negative 2%, a 75 basis point improvement at the midpoint. Our updated guidance range implies a deceleration in same-property NOI growth throughout the second half of the year, largely due to the previously discussed impact of one-time items in the second quarter of this year. In addition, we recognized significant restoration in settlement fee income in the fourth quarter of 2024, which will create a difficult comparison for the fourth quarter of 2025. As Angela previously mentioned, we have updated our capitalization assumptions for the Flower Mart. When we initiated 2025 guidance in February, the range of possible outcomes reflected the uncertainty inherent in the process with the cessation of capitalization ranging from as early as June to the latest December. Given the progress we have made today, we have updated our expectations for the cessation of interest and other expense capitalization to year-end. We will update this as appropriate, but as previously mentioned, we are not currently assuming any capitalization of the project in 2026. Relative to sources and uses for the back half of this year, we expect to utilize the proceeds from the announced dispositions for a combination of reinvestment opportunities and debt repayment. As we approach our remaining 2025 bond maturity, we will evaluate the capital markets for an opportunistic execution window. Our balance sheet is well positioned to support growth with a well-laddered maturity schedule and strong liquidity, which will provide valuable flexibility as opportunities present themselves. With that, we're happy to take your questions.

Our first question today comes from the line of Jana Galan with Bank of America.

Congrats on the leasing and transactions this quarter. Can you talk a little bit about the type of buyers out there, the breadth of the bidding pool, and whether you're seeing some owner occupants? And then just discussions on valuation, whether it's more of a price per square foot discussion or cap rates and whether it's different in San Francisco versus L.A.?

Jana, it's Eliott. So every transaction is going to be different, and we touched on this a little bit last quarter with the different types of groups that we've seen out there. And there's everything from institutional buyers to high-net-worth to owner users, and each group is going to think about it a little bit differently depending on the profile of the asset. So it's a little bit hard to kind of generalize, but what we've seen with the transactions that we completed were pretty good debt, frankly, across all these different types of opportunities. Each group is very different. The 26th Street is an example, since that was going to a residential developer, had a very different set of folks that showed up relative to 501 Santa Monica. So we've been pretty methodical with how we've tried to approach the disposition market. And now that we're seeing some depth there, that kind of gave us confidence early in the year to start testing, and we like what we saw, which is why we executed.

Yes. I mean, I'd just add to that. I agree with everything Eliott said. I do think you're seeing a widening out of the types of players that are evaluating particularly operating office assets in our core markets across the West Coast. As I mentioned in my prepared remarks, I think it really speaks to growing conviction in the continued path of the West Coast office recovery, which is a very encouraging sign. A lot more institutional buyers than what we would have seen 6 or 9 months ago.

Great. And then on kind of the use of proceeds, you mentioned reinvestment and debt repayment, but also leverage neutral share buybacks. Can you remind us kind of what your authorization is now in the buybacks?

Yes. I think the total authorization size is about $400 million. So we've got capacity. We had re-upped that program, I think, around the time that I started. So we haven't used it. So we've got almost full authorization under that program.

Could you provide more detail on KOP 2 and its activity? You mentioned 100,000 feet—will it be for life science or traditional office use? Additionally, could you discuss the economics and how these deals compare to your original underwriting?

Yes. Thanks, Steve. We're really very encouraged by the activity we've seen and continue to see at KOP. We've been talking about the kind of growing pipeline there for some time and the amount of tour activity that asset has seen. And we feel like the project that we delivered late last year is just really hitting the mark in terms of tenants that are looking for high-quality, purpose-built life science product, highly amenitized and in that core life science ecosystem. So the amount of activity we're seeing has been really, really encouraging. As I mentioned in my remarks, even despite some headwinds from a life science broader ecosystem perspective. What we did say on the call is we've moved to active lease negotiations with about 100,000 feet of primarily healthcare and life science tenants. So they're all more traditional life science healthcare uses. We do think that the project retains broad-based appeal to a wide range of potential tenants that are in the market, including more tech uses, people that would have demand for dry labs, more office-specific uses, but we do think this first 100,000 square feet will execute or more life science and healthcare-oriented. So that's exciting for the project and bodes well for future growth and future phases as well. I think it's too early to talk more specifically about the economics. I think rents have held up pretty well. They're certainly just given what's happened to the broader ecosystem overall, there is more capital going into certain projects. But we think relative to the way this project was originally underwritten, we feel really good about the activity and how it's stacking up, but as we get leases signed, we can probably update more specifically.

Okay. And then secondly, I know it's a bit early to really turn your eye to '26, but the lease expiration schedule does remain a bit elevated even though you were able to kind of remove I think, a large expiration with the pending sales in Silicon Valley. But just how are you thinking about retention for next year? And I guess do you have a thought on kind of when occupancy in the portfolio may bottom?

Yes. I mean, let me take that in 2 pieces. One, just to talk about the occupancy trajectory for 2025, and then I'll sort of touch on your broader question for 2026. 2025, and this is consistent with what we've been saying for the last couple of quarters. The Q2 decline was fully expected. We had a downsize of a tenant that had gone bankrupt and was bought by another entity. We did a downsize in the second quarter. We also had a vacate related to the 23andMe bankruptcy. So those we saw coming and had communicated about them on the last call. As we look out to the third quarter, I still think we're somewhat negative net absorption in Q3, but you are going to see a bigger occupancy impact due to the 2 redevelopment assets coming into the pool in Q3. So we should all be expecting that. The signed but not commenced pool has now grown to 270 basis points, which represents a significant source of growth as we look into the second half of 2025 and into 2026. We've got 3 significant lease commencements coming out of that pool in the fourth quarter. So I fully expect that fourth quarter of this year we’ll have positive net absorption. As we look into 2026, a few things to note. One, KOP comes into the pool in January of next year. And despite the fact that we're making really good progress, I think, on leasing activity at that property, nothing is going to be built for occupancy at the time it comes into the pool. So that's going to set us back from a reported occupancy perspective, not necessarily a like-for-like occupancy perspective, but something we should all be prepared for. As we look at the expiration schedule for next year, obviously, we've been really diligently working on addressing those expirations. And the sale of the 4-building campus in Silicon Valley certainly addresses a significant portion of what we believe was going to be a vacate in 2026. The lease expiration schedule is relatively first half weighted, especially in Q2. I think if you look at the lease expiration disclosure in the Q, the leasing team is working diligently across that entire pipeline to work with tenants to understand their needs for next year and address those as much as we can. But I do expect that we're going to see some larger vacates in the first half of the year. So we'll know more as we get into the next quarter or 2, but I do think retention that continues to be somewhat below our historical average is likely in 2026. It's hard to talk more specifically about the timing of an occupancy trough next year as we feel this leasing momentum across the portfolio, both the operating portfolio and the development portfolio building. So I think we need another quarter or so to be able to give more specifics about the timing of occupancy or the trajectory of occupancy within 2026. But I think those are all important considerations as you think about next year.

I guess first question is just following up on the activity you cited at KOP 2. Can you just talk about if that would be for some of the spec suites where commencement of NOI could be sooner, if it's related to that space?

One of the transactions, we mentioned working on multiple transactions, one of the multiple transactions we're working on would be per spec suite user. We also think within the tour activity that's building at the project or is accelerated, there's additional spec suite users, but again, even if we sign in Q3 or Q4 of this year could potentially be first half next year occupancy.

Okay. Great. And then just second question is going back to the campus that you have in the works to sell? I mean, I know you gave some metrics on it. Is there any way to maybe talk a little bit more about how you're thinking about the pricing? And you said that you thought it was a good price relative to if you had to re-lease the asset. I know there was some leasing activity going on, but any more of just sort of like a cap rate type impact, stabilized yield on cost? How to sort of think about that transaction pricing?

Nick, it's Eliott. We're somewhat limited by an NDA, so I can't share too many specifics about the transaction. However, when we consider our asset sales, we evaluate the expected proceeds and our forward-looking outlook for cash flows at that specific project. This assessment includes any necessary leasing, capital expenditures, and our perspective on future rent trends. If we determine that the anticipated return at a certain value isn't substantial, that leads us to consider selling. On the other hand, if we find the value appealing, we may choose to retain it. Essentially, we conduct a comprehensive analysis for any potential sale.

One of the most common questions and concerns about the market that we hear is how to think about the net impact of AI with respect to office space requirements and leasing. Clearly, the AI companies are taking space, but we've seen some additional layoffs from big tech companies that seem to be related to AI displacement. So just wanted to see if you have any thoughts on that net impact of AI?

Yes, thank you, Blaine. This is an important topic to keep monitoring and assessing. When we examine our markets, there are a few different factors at play that are challenging to separate. It's easy to point to job losses, particularly from the traditional tech sector, and to see some leaders from those companies attributing those losses solely to AI. However, we must also consider that we are transitioning from a time with significant over-hiring at the onset of the pandemic. Separating these elements can be complicated. A more positive trend we’re witnessing is that companies, not only in tech but across corporate America, are starting to see AI not merely as a means of efficiency but as a growth strategy and opportunity. While it may be tempting to focus on the jobs that could be automated due to AI advancements, it is much harder to imagine the new jobs that will be created as a result. I'm optimistic about our market positioning as we begin to observe these trends and contemplate how various markets will be affected. Markets like San Francisco, Seattle, San Diego, and to some extent, Los Angeles, are starting to benefit from the momentum generated by new jobs and industries arising from AI. Therefore, it's definitely a trend to keep an eye on. We must be mindful of its implications for our long-term capital allocation strategy, but I believe this portfolio will also gain from these developments in the near to medium term.

Okay. Great. That's very helpful. And then just my second question, just touching back on dispositions. I guess, how would you characterize the size of the portfolio that you'd consider as non-core within the KRC portfolio? And are there any specific characteristics you're looking to get away from, whether that's by market or asset quality or otherwise?

Yes, I'll start, and then I’ll let Eliott provide more details. When we consider dispositions across the portfolio, I want to emphasize that we are optimistic about all the markets we operate in and see potential for growth in several of them, including the Pacific Northwest, Bellevue, Seattle, San Diego, and Austin. We believe there are significant growth opportunities in these areas. In San Francisco and L.A., we are focusing on ensuring that our portfolios in these markets are strategically positioned. We referenced this during the call, as it is essential that we are engaged in the best-performing submarkets within these core areas, which will play a crucial role in our capital allocation moving forward. Ultimately, regardless of the market situation, it returns to what Eliott mentioned earlier: we are committed to asset-by-asset evaluation to ensure that every dollar we invest in the portfolio yields a return that exceeds our cost of capital. Thus, we are considering the overall construction of the portfolio while ensuring we are invested in submarkets that can provide the durability and growth we seek in cash flow. Additionally, we need to carefully assess individual asset pricing to determine where we can or should realize capital for redeployment in other areas.

Yes, not much to add to that. But we touched on this a little bit last quarter. We're essentially looking at where our fundamental outlook overlays with where there is capital. And so if we see a good match between where our outlook is a little bit more pessimistic, but there is capital that is taking the other perspective that makes a good disposition candidate for us.

In the prepared remarks, you mentioned that you're kind of getting to the end of some of the larger space givebacks. Just kind of on the leasing pipeline, could you give more color on the types of tenants in the pipeline? Is it predominantly smaller to medium-sized tenants? Or are you starting to see a turn of larger tenants coming back into the market?

It's Rob Paratte. I think it's sort of across the board. We have larger tenants that we're talking to in different submarkets, and we also have the typical deal size in a market like San Francisco, excluding the big deals, it's probably in the 25,000 to 30,000 foot range, and there's a lot of activity in that range. In San Diego, where we are in North County, deals again tend to be in the 20,000, 30,000, 40,000 foot size range. But if you go to some of the really stellar markets like Bellevue, where we're operating, deals are over 100,000 feet. So as the recovery takes hold, you're seeing a pretty wide variety of transaction sizes and types of users. So using San Francisco, as an example, everyone is focused on AI, but law firms, crypto and banks have been quite active in that market. So you've got a blend of technology categories mixed with traditional sectors.

Yes. I mean I think just to add on to that, as Rob said, we're seeing broad-based demand, right, and all sort of size ranges. So one dynamic I'd sort of reemphasize, and we've talked about this on prior calls, is kind of what's happening with some of these tenants that might look like small deals in the San Francisco market, but are actually second, third, fourth expansions of AI tenants that are just growing really rapidly. And when those leases come up for lease renewal or they're looking at evaluating the market again in a few years, those are going to be pretty substantial company. There's a different question between what's the size of execution, what's the size of the company in the market today. Those are sort of disconnected in a market like San Francisco because of this dynamic with AI companies taking the space they need today, but then growing incrementally over time pretty quickly. So it's an interesting dynamic to watch and to see play out.

Great. And then I know you don't have direct studio exposure, but just in terms of LA demand. Are you seeing any impact there from the tax incentives for that market?

Not just yet. I mean I think we've seen some encouraging data on production that might be slated to come back to the market over the next couple of years. But it's been too early to see that impact, I think, near-term demand just tied to AI.

Maybe just back to Flower Mart. I was wondering if you could go through some of the types of conversations that you're having with the city. And I guess the thought is then what's the chance that they go beyond December 31? And to the extent you don't want to specifically comment on that, just kind of what's taken it from a potential of June 30 now December 31. In my kind of what's left in that potential timing that's left?

Yes. I mean there's still a lot of variables at play here. And so what we're trying to do is provide as much transparency we can when we can provide it. And that's what we did when we initiated guidance this year. There were so many different paths this project could have taken, including, we could have had the city really shut down sort of our hopes that getting greater flexibility and optionality on the site. So what we now know that we didn't know at the beginning of the year is that the city has been very receptive to working with us on a revised program that would allow us, hopefully, and what we're asking for is to maintain a lot of the entitlements we have in place, which is for a very high-density plan that has tremendous amounts of value in the right kind of market while also getting flexibility to change that plan or to modify that plan in a way that's responsive to the community and the market needs in central SoMa and hopefully can allow us to phase the development. So you could see development in central SoMa market earlier than you might have otherwise. This city has been receptive. We've had conversations with them over the last couple of quarters, including some pretty recent conversations. We expect that there will be additional steps we're going to take here in the back half of the year, and we'll know more and be able to provide additional updates on next quarter's call. But for right now, our current assumption is that some of these efforts are completed by year-end, and we're not assuming any additional capitalization next year, but we will continue to update.

Got it. And then, Rob, I know you talked in one of your prior responses about the varying sizes of leases that you're seeing in like San Francisco versus San Diego. I guess, as you think about some of the differences of San Francisco versus those other markets? And like what's driving those differences today?

Yes, Caitlin. The main factor in San Francisco is the venture capital funding directed towards AI in the city. When you combine that with the talent available in San Francisco, it creates strong demand. We expect that demand to grow in Seattle as well, especially with companies like NVIDIA and DataBricks in our portfolio. There's no reason this trend shouldn't continue since the same talent pool exists in Seattle and Bellevue. Los Angeles, however, is a mixed market, and we hope to see more activity on the left side, as it's puzzling why it has been slower. Currently, the successful submarkets in L.A. are Central City and Beverly Hills, both performing well, along with Culver City. With Apple completing their 500,000-square-foot campus, we can expect ongoing content production associated with Hollywood. These are the key drivers. San Francisco and Seattle are notable for their technology innovation, while in San Diego, we're distinguishing our product from typical older high-rise buildings by working with companies that have thought leaders developing new ideas. We've seen expansions from large firms like private banking, Boston Consulting Group, and JPMorgan in our portfolio thanks to the talent base. It's also important to mention that San Diego has a robust life sciences market, particularly in UTC, Torrey Pines, and Del Mar. This innovation, though somewhat different from San Francisco because it's life sciences, provides a benefit to San Diego. In the future, we might also see benefits from defense spending in San Diego, which has historically been a strong defense market.

On KOT 2, I was wondering if you could provide some color on whether or not these tenants are moving into South San Francisco or if they're just expanding or moving around within the submarket? And if you could provide any update on development yields, I think historically, we were looking at this at an 8% plus. I was wondering if that's still on the table.

John, I will answer the second one, and I'll address the first one. It's Rob. It's a variety. Again, some are in South San Francisco, some are new to market. And all I would say is the most active. If you look at the Bay Area as a whole in terms of life science, the most active submarket or sub portion of the market is South San Francisco and the Peninsula, which is directly adjacent. So again, we'll be able to give you a lot more color when we sign these, but it's a pretty broad spectrum.

Yes. I addressed the return point earlier. Let us finalize some of these deals, and we can provide better updates on their progress and outlook. I want to emphasize that the project was underwritten quite conservatively. Rents appear strong, but there is certainly more capital involved in some of these deals than we initially expected, which reflects broader trends in life science rather than this specific project. As we continue to secure leasing, we will share more updates.

Okay. Fair enough. On the Matilda campus sale, can you discuss the alternatives for the campus? I know, Eliott, you mentioned that the CapEx requirement was most likely. But was there a direct lease with a subtenant that was an option for you? And how do you weigh that versus selling the assets? And also if you could confirm what the cap rate was at back of this, we get to like a low 8% cap rate, but I was wondering what your perspective was?

John, so as I mentioned earlier, we're on a pretty tight NDA, so we're somewhat restricted in what we could talk about here. But I think that you hit on an important point, which we sort of tried to touch on in the prepared remarks, which is the campus today is a little more occupied. And as we look forward, it's not going to have that same level of occupancy. So then the question becomes, what does that look like to try to lease it up? And we evaluated a few different scenarios on what that would potentially look like. And in all of those different scenarios, we kind of concluded that to get the $365 million was more advantageous than trying to lease it up, spend the capital, and get the kind of rents that we deem as market. So based on all of that, that's kind of how we came to the decision that this was a transaction worth pursuing.

Angela, it sounds like there could be more demand at KOP coming behind the 100,000 square feet you referenced. Can you provide some color on the prospects that are in the earlier phases of the planning?

Yes. I believe there continues to be a wide range of applications in life sciences and healthcare-related uses, including biomedical institutions, public biotech, and private biotech across various sectors. Additionally, we're observing strong demand from more traditional tech applications, as well as some AI uses that require dry lab space. There has definitely been a significant increase in our activity, and some of the deals we are currently pursuing are generating real momentum on the campus. We are optimistic about what is ahead, but we are also very focused on securing and finalizing the first 100,000 square feet.

Our next question comes from Upal Rana with KeyCorp.

Angela, you mentioned the $150 million monetization goal, which you're about halfway there. Given the state of the transaction market, do you anticipate there could be some upside to monetizing more land?

Yes. I believe we are putting in considerable effort to assess the best uses for every parcel in our future land bank. We have some parcels at KOP that we are excited about for potential growth. Conversations with current tenants and those interested in Phase II indicate that the growth and scalability of the campus are significant advantages for KOP. We have discussed the Flower Mart extensively, which is the largest part of our future land bank. We think that maximizing value there involves continuing our expansion efforts. We are working on providing more flexibility with the entitlements and developing a program that allows us to phase our execution responsibly. These are two specific areas of the future land bank that we will evaluate uniquely. For the rest, we are actively considering and working on identifying the highest and best uses. If those uses fall outside our core strengths, we are looking at monetizing those parcels. There is certainly potential for more, and we will update you after our announcements. We have been proactive about addressing the future land bank and recognizing changes in submarkets that require us to adapt to exploit higher and best uses.

Okay. Great. That was helpful. And then on the increase in demand you're seeing in San Francisco, is there an impact of companies who had moved out of the area during the pandemic that are now coming back? Or would you say it's more homegrown demand?

There are fewer companies that have moved out and are now returning. While there have been some reports about this, much of the demand is driven by new company formations or expansions. For example, JPMorgan renewing and expanding its presence in South of Market is significant, as it reflects growing confidence in the market and business opportunities for banks. Companies are primarily seeking talent and quality spaces. There’s a clear distinction in the vacancy rates between leasable space and obsolete space. Companies poised for growth, like the AI firm we partnered with at 201 Third, are looking for quality buildings with amenities, which will attract them to the city or encourage those already there to remain. Moreover, these companies are bringing their employees back to the workplace, necessitating suitable space.

I just wanted to go back to Caitlin's question around Flower Mart. And again, I guess I'm still struggling to understand the change in capitalization exactly what's really driving that? And then second of all, if you do end up with the local government kind of rethinking the project and you kind of get what you want, doesn't that kind of suggest you keep capitalizing in '26, because you're going to probably continue with development along those lines?

Thank you for the question. I want to revisit how we initially communicated our guidance. We aimed for more flexible entitlements to allow for varied development phasing on-site. At that time, it wasn't clear if this approach would be accepted by the city. We laid out a clear path in our original guidance, but it wasn't agreeable to all stakeholders. By June 30, we likely reached a pause in our plans, which is reflected in the low end of our guidance, as we did not capitalize for the latter half of the year. Currently, we feel optimistic about our discussions with the city, which are ongoing. We're actively redesigning and reimagining the Flower Mart project. There are still steps we need to take in the second half of the year, and we will clarify these as information becomes public. We anticipate that many of these tasks will be completed by year-end, at which point we'll stop capitalizing. There is a scenario where we could achieve flexibility regarding entitlements, but it may not lead us to start the project immediately. If we cease additional design work and development activities related to accounting guidelines, we must stop capitalizing. If those activities persist, we can continue capitalizing; however, this is a straightforward decision tied to the activities we undertake at the Flower Mart by year-end. As we sit here in July, we can't predict our exact position at year-end, which is why we are committed to transparency and will provide clear updates on the next quarter's call and beyond. That's the most accurate information we have at this moment.

I have a quick follow-up on Flower Mart, and I know that was a very detailed explanation, so that was pretty helpful. But how soon do you think you could be willing to start a new development? Like you've got your new entitlement projects, would there be a scenario where you could start a new development, especially if it's a non-office build? Or is that something that Kilroy would be willing to do? Or would you want to bring a partner to kind of do that if it's like a different use like a residential type thing?

There are many aspects to consider in that question, and I appreciate its depth. We will need to assess the situation as we progress. It's important to gain a clearer understanding of the overall site layout and how any residential components might connect with future office development projects. We must determine if these elements can stand on their own, if there are overarching control issues that could affect office development, or if we can fully monetize them. These are all factors that will need to be addressed as we move forward with redesigning and reimagining the overall plan. At this stage, it's too early for a definitive answer, but I'm committed to maintaining transparency as we continue.

Okay. That's great. That's helpful. And then just lastly, I know in the prepared remarks that you mentioned that there are selective reinvestment opportunities that the company is pursuing after you kind of get these asset sale proceeds. I mean, should we think about this as new real estate type of investments? I mean, if that's the case, is this kind of like an acquisition and development opportunities? Or what do those selective reinvestment opportunities look like?

Michael, it's Eliott. So they're kind of all over the board, but not drastically different from the things that we've looked at historically. We're probably less inclined to do spec development. But I think outside of that, any kind of acquisition that has some sort of value-add component or maybe it's a little bit more of a core plus type opportunity, something where we think we can bring some sort of expertise, whether that's leasing expertise or whether that's capital expertise in a market that we think we know well or we think has pretty good growth prospects. And as we sort of alluded to in our remarks, there are a bunch of those that we're evaluating over several different markets and submarkets, and we'll kind of see how they play out.

I appreciate all the comments that you guys have made related to sort of the demand pipeline, turning activity and whatnot. But I guess just one quick one as it relates to sort of new leasing. Obviously, a very strong quarter in 2Q. I mean, do you guys get the sense for that sort of being a good annualized run rate of, call it, new leasing of 1 million square foot on an annualized basis? Or was it maybe 1 or 2 large leases that drove that higher this quarter? Can you guys just talk about sort of expectations on the new leasing front?

Yes, thanks, Dylan. I appreciate it. We have discussed the growing pipeline and the enthusiasm surrounding the acceleration of our development portfolio leasing, which makes us feel optimistic. Regarding the operating portfolio balance, the team is performing exceptionally well across markets in generating new leasing and concentrating on expirations we anticipate in the latter half of '22 and extending into 2026. There is a lot of positive activity building. While I'm reluctant to commit to a specific number, I feel more encouraged now than I have been over the past year and a half regarding how leasing is developing and the sustainability of the demand we're witnessing in our core markets. I am definitely optimistic, and now we need to focus on executing our plans.

I just wanted to turn back to 2026 expirations. I think at one point, you talked about like a 200,000 square foot expiration and it was a large tenant that you thought would stay, but they could downsize. And I just want to see if you have any update on that or any of the other expirations next year?

Yes. No update specifically on that at this point. What I did mention earlier is that we're very focused, especially in those expirations in the first half of 2026, where many of our 2026 expirations are pretty weighted, particularly in the second quarter. I do expect that we're going to have a few larger vacates or significant downsizes in that first half of the year time frame. We're actively working on discussions with many of those tenants now. It's just too early to say with finality.

So Rob, you may have answered this in a prior response to the question, but I guess on AI specifically, given that it sounds like it's a decent amount of the pipeline, can you talk more about the exact types of buildings, locations, urban versus suburban, floor sizes, power needs, amenities and build-outs we might see for those types of tenants? Is it any different from what you see from a typical tenant and market?

Yes, Jamie. There is a range of considerations here. Younger AI companies tend to seek out pre-built spaces that are ready for occupancy and may look for nearby areas to expand into as they continue to secure funding and grow. Their power requirements align with typical office users since most of our AI tenants are not directly using power on-site; much of it is generated off-site or it's not research and development space that we are leasing. In San Francisco, having a floor plate of about 30,000 square feet, like ours, is essential. Currently, tenants are not looking for the larger floor plates of 70,000 or 100,000 square feet that were in demand during the previous cycle. A 30,000 square foot floor is very efficient. These companies prefer a straightforward rectangular layout with a central core and ample open space. The amenities they prioritize are similar to those of other tenants, including usable outdoor areas, dining options, and fitness facilities either within the building or nearby. Our business centers, among other features, are particularly attractive to tenants. Having these amenities on-site allows younger companies to avoid the need to develop additional services like food service or conference centers. They are also generally more efficient in their use of space, which will benefit us and other landlords as they grow.

Yes. I mean the biggest dynamic in just everything Rob just said, that we continue to point out is that these tenants are really looking for flexibility. They're growing very quickly, and they're looking for landlords that will work with them to accommodate that future growth where possible. And so that's been a key focus in terms of how Rob and the team have really gotten to understand exactly what they're looking for. We're also working really hard, whether it's our spec suite program or in some recent examples, using existing build-outs in space that might have been vacated pretty recently because these tenants are really focused on taking occupancy as quickly as possible. Those are all really encouraging dynamics for us as landlords in a market like San Francisco and at this stage of the recovery. So we've really been leaning in and figuring out how to meet those needs as well as we can.

Thank you. We have no further questions. And so this concludes our call. Thank you all for your participation, and you may now disconnect your lines.