Earnings Call Transcript
Kilroy Realty Corp (KRC)
Earnings Call Transcript - KRC Q1 2022
Operator, Operator
Hello, and a warm welcome to today's First Quarter 2022 Kilroy Realty Corporation Earnings Conference Call. My name is Emera and I'll be coordinating the call today. It's now my pleasure to hand today's call over to Bill Hutchison, Senior Vice President of Investor Relations, to begin. Please go ahead.
Bill Hutchison, Senior Vice President of Investor Relations
Thank you, Emera. Good morning, everyone. Thank you for joining us. On the call with me today are John Kilroy, Tyler Rose, Rob Paratte, and Eliott Trencher. At the outset, I need to say that some of the information we will be discussing during this call is forward-looking in nature. Please refer to our supplemental package for a statement regarding the forward-looking information on this call and in the supplemental. This call is being telecast live on our website and will be available for replay for the next eight days, both by phone and over the Internet. Our earnings release and supplemental package have been filed on Form 8-K with the SEC, and both are available on our website. John will start the call with first-quarter highlights, and Eliott will discuss our financial results and provide you with updated 2022 earnings guidance. Then we'll be happy to take your questions. John?
John Kilroy, CEO
Thank you, Bill. Hello, everybody. Thank you for joining us today. I'll begin with some big picture comments and then share highlights from the quarter. We recently passed the two-year mark from the start of the pandemic and are starting to see what a new normal looks like. People are returning to cities, kids are attending school in person, and travel has returned. On that last point, it was great to see so many of you live at the Citigroup conference in March. Physical office occupancy has continued to progress. Many of our largest customers started returning to the office in recent weeks, the effects of which are tangible in our markets. Traffic is up. Public transportation is more crowded. Cities are cleaning up and starting to feel more vibrant. Ridership on BART in the Bay Area was up roughly 20% versus last month and over 140% versus last year. We are encouraged by the initiative San Francisco took last month with their welcome back to SF plan, encouraging employers to return to the office. Those who signed the pledge, including many companies such as Google, Microsoft, Meta, Salesforce, Uber, and Kilroy, committed to implement in-person work policies beginning in March. So while we expect the coming months to have some fits and starts, we are feeling more encouraged by the progress to date. One thing that has not changed throughout the pandemic is the importance of technology and life science companies as an engine that drives our economy. Since the start of the pandemic, over two years ago, the NASDAQ is up roughly 90%, and VC funding is up 85%. So while there will be volatility year-to-year, access to capital for these industries remains robust. Hiring continues to be very healthy as well. Job postings from large technology companies in our markets are up roughly 75% year-over-year, highlighting the growth and competition for talent on the West Coast and in Austin. Despite all the headlines, companies continue to lease office space. According to JLL, leasing nationwide has increased for five straight quarters. In the first quarter of 2022, leasing volume represented approximately 75% of pre-pandemic levels. Technology and life science customers remain a major driver of demand, especially in our markets. A few examples include: Meta signed a nearly 600,000 square foot lease in Downtown Austin and a 200,000 square foot lease in Bellevue. Bristol-Myers Squibb took over 400,000 square feet in the UTC submarket in San Diego, and Roblox, a gaming company, leased 200,000 square feet in the Bay Area, just to name a few. Not surprisingly, a disproportionate amount of this leasing has been in newer and more amenitized buildings. Our strategy has long been to buy and build the best office and life science buildings in our markets in order to attract big, sophisticated, and growing users. A Green Street report from last month analyzed portfolio quality among the publicly traded office companies, and Kilroy scored over 90 out of a possible 100 points, ranking us number one in our group of peers. Our commitment to modern, amenitized, and sustainable workplace environments differentiates our portfolio and positions us to succeed in multiple environments. On this note, we'd like to point out that earlier this month, we filed our 11th Annual Sustainability Report. Sustainability, health, and wellness are integral to both us and our partners. Our efforts continue to earn global recognition from leading organizations, including GRESB, Dow Jones, NAREIT, and ENERGY STAR. These initiatives remain central to Kilroy's values, and we plan to continue leading in these areas. But we are not without challenges. Geopolitical risk is elevated, inflation is accelerating, and the capital markets remain somewhat volatile. While these macro factors are beyond our control, our long-term leases, high concentration of creditworthy tenants, and low leverage provide a buffer to navigate any short-term choppiness. In summary, our portfolio quality, strong tenant credit, and fortress balance sheet position us for both defense and offense. Our downside will be protected in tough times, as seen by the resilience of our portfolio during the pandemic, and we are prepared to be opportunistic when appropriate, as we demonstrated through active capital recycling this past year. Turning to the highlights for the first quarter, leasing was headlined by the renewal and expansion of Nuro for 114,000 square feet in Mountain View through 2032. We are pleased to grow with this innovative company, which represents another VC-backed company expanding in the Bay Area. After a slow start due to the Omicron variant, activity improved throughout the quarter, and we are currently in late-stage negotiations on more than 350,000 square feet of office space in our core portfolio across multiple markets. While there are no guarantees these leases get done, it demonstrates the improved tenant confidence in the market. Overall leasing spreads on deals signed during the quarter were plus 7%; it is worth noting that our leasing spreads stayed positive every quarter throughout the pandemic, a testament to the quality of our real estate and the built-in growth within our portfolio. Our lease rollover remains modest, with an average of 7% expiring per year through 2025. We continue to see strong residential demand in our markets, which is good for our multifamily portfolio in the near term and encouraging for our office portfolio in the longer term. Our roughly 1,000 residential units are 97% leased as of today. Jardine, our most recent project in Hollywood, now sits at 94% leased, a mere 11 months since delivery, and is achieving top-of-the-market rents at nearly $6 per square foot. Life science continues to be a point of strength across all markets, with vacancy rates in the low single digits. Leasing activity for life science projects remains robust, and we continue to have good interest in both Kilroy Oyster Point and our future site in San Diego, Santa Fe Summit. As a reminder, upon completion of all phases of these developments, NOI from life science properties could get as high as 30% of total company. On the capital allocation front, we began construction on the last two San Diego life science redevelopments we discussed last quarter. In total, we now have three life science redevelopments, which have an estimated total cost of $115 million or roughly $60 million of incremental spend. All three projects are fully leased, and upon stabilization, will generate $20 million in total NOI or $10 million above pre-redevelopment levels. Additionally, during the quarter, we continued our expansion in Austin by acquiring a land site in the Stadium District for $40 million. The Stadium District, together with the adjacent domain submarket, has become Austin's second downtown, with 4,000 apartments, 50 restaurants, and 900 hotel rooms in close proximity. The Class A office market is roughly three million square feet and is 99% leased to several customers, including Amazon, Meta, and Indeed. Our site is located kitty-corner to the southern end of the domain, close to a future light rail stop that connects to downtown. Most importantly, it is directly adjacent to the brand-new Q2 Stadium, home to Austin FC, the region's only professional sports team. As part of the land acquisition, we have a permit-ready, high-quality design from one of our favorite architects, which allows us to lock in a general contractor, which we've done with the builder. We expect to start construction later this year. In total, we expect to spend just over $700 per square foot, including the entitled land, which, as I mentioned, we previously closed on to develop what we believe will be the best building in the submarket, complementing the Indeed tower, the premium building in the Austin CBD. We have also made progress building out our team in the region. We recently announced the addition of Fernando Urrutia, Senior VP of Leasing, for our Austin-based team. Fernando, a graduate of UT, has been in Texas commercial real estate for over a decade and brings to Kilroy Austin market relationships, leasing acumen, and transaction expertise. Two very seasoned Kilroy executives will also be relocating from the West Coast to oversee asset management and construction in the Austin market. To recap, since June of 2021, we have acquired two projects in Austin that will total 1.2 million square feet or roughly 5% of total company NOI and put together the foundation of a local team that will facilitate our continued expansion in the region. In closing, last quarter, I outlined five objectives for the year: complete and lease our development projects, proactively manage the operating portfolio, look for external growth opportunities, maintain a conservative balance sheet, and lastly, engage politically when necessary to help shape public policy. While it is still early in the year, we are pleased with the progress on several of these initiatives and we remain committed to these goals as the year progresses. That completes my remarks. Now I'll turn the call over to Eliott.
Eliott Trencher, CFO
Thank you, John. FFO was $1.16 per share in the first quarter. This includes $0.03 of positive one-time items from lease termination fees and moving some retail tenants back onto accrual accounting, offset by $0.01 of front-loaded G&A spend. Taking the net of the two, adjusted FFO for the first quarter was $1.14 per share or $0.04 higher than last quarter, largely driven by a full quarter of revenue from Kilroy Oyster Point Phase 1. On a same-store basis, first quarter cash NOI was up 12.8%, excluding one-time items and adjusting for tenants that were not paying rent in the first quarter of last year, cash same-store NOI was 10.1% for the quarter. This growth was driven by lease-up at the residential portion of One Paseo and free rent burn-off for some larger office leases. GAAP same-store NOI was up 9.1%. At the end of the quarter, our stabilized portfolio was 91% occupied and 93% leased. The decrease in occupancy from the fourth quarter was driven by a 145,000 square foot move-out in San Diego that we previously discussed. Turning to the balance sheet, our liquidity today stands at approximately $1.3 billion, including approximately $175 million in cash and full availability of our $1.1 billion revolver. As we have previously discussed, our line of credit, combined with cash on hand and our projected dispositions will more than fund the development pipeline through 2022. Net debt to Q1 annualized EBITDA was 5.9 times, and we have no debt maturities until December of 2024. As a reminder, last year, we issued $450 million of bonds at 2.65% and used the proceeds to redeem our 2023 maturity, thereby giving us plenty of runway to navigate the current debt markets. Before we get to guidance, one change we made to our disclosure this quarter is on page 18 of the supplemental, where we expanded the pool of deals for the change in rent calculation. Previously, this number was based on spaces that had been vacant for 12 months or less. Given the decrease in activity during the pandemic, we are starting to see leasing in more spaces that have been vacant for longer than 12 months. So beginning this quarter, our change in rent calculation includes spaces that have been vacant since the start of the pandemic, which should give investors a better sense of what is going on in the portfolio. As John mentioned earlier, our leasing spreads on deals signed this quarter were plus 7%. Had we used our old methodology, it would have been plus 6%. Now let's discuss our updated 2022 guidance. To begin, let me remind you that we approach our near-term performance forecasting with a high degree of caution, given all the uncertainties in today's economy. Our current guidance reflects information and market intelligence as we know it today. Any COVID-related impact or significant shifts in the economy, our markets, tenant demand, construction costs, and new supply going forward could have a meaningful impact on our results in ways not currently reflected in our analysis. Projected revenue recognition dates are subject to several factors that we can't control, including the timing of tenant occupancies. With those caveats, our updated assumptions for 2022 are as follows. As always, acquisitions are forecasted. We continue to assume $200 million to $500 million of dispositions. Development spending for the balance of the year is expected to be $500 million to $575 million, a modest increase from our prior forecast due to the inclusion of our recently acquired Austin site. We expect to commence revenue recognition for the remaining 51% of 333 Dexter by the third quarter and for 250,000 square feet of life science redevelopments by the early fourth quarter. It is important to note that the prior tenants for 12400 High Bluff and 4690 Executive Drive, our life science redevelopments in San Diego, moved out in the first quarter; therefore, NOI at those properties will drop over the next couple of quarters before ramping back up in the fourth quarter. Since these buildings are now in the redevelopment pipeline, it does not show up in our occupancy. Year-end occupancy is still projected to be 91% to 92% for the office portfolio, and residential occupancy is projected to stay around current levels. Same-store cash NOI is expected to be between 5% and 6%, a 50 basis point increase at the midpoint due to the strong results from the first quarter. Putting this all together, we project 2022 FFO per share to range between $4.44 to $4.58, with a midpoint of $4.51, which is a $0.06 increase compared to our prior guidance. The implied run rate in our new guidance is below the first quarter results due to the dispositions expected to occur over the balance of the year, which have a roughly $0.11 impact and from the $0.02 of net nonrecurring items in the first quarter. That completes my remarks, and we'll be happy to take your questions.
Operator, Operator
Thank you. Our first question today comes from Nick Yulico from Scotiabank. Nick, please go ahead. Your line is now open.
Nick Yulico, Analyst
Thank you. Maybe sticking with the guidance, Eliott, I just wanted to be clear in this. So it sounded like there was - you said a $0.02 nonrecurring item in the first quarter, and so guidance went up $0.06. So just trying to understand what's the difference in the delta and the rest of the guidance raise?
Tyler Rose, CRO
Yes. So you can roughly break it up into three buckets, and it's about a third, third, to third. A third being the one-time, the net one-time items that you outlined, a third being the residential portfolio, which was strong in both the first quarter, and the last third was sort of miscellaneous other, including some earlier lease starts and capital interest being slightly higher.
Nick Yulico, Analyst
Okay. Thanks. And then I guess maybe a question for Rob or someone else. Just maybe an update on some of the leasing conversations you're having and the dichotomy between some of the markets you're focused on?
Rob Paratte, COO
Sure. How are you doing, Nick? Let me give you a broad overview to start with just four points I'd like to make. And these points are tied directly to Kilroy's portfolio, where we operate, where all the top-tier talent pools are located, and where you're seeing a flight to quality. But the four points are, as John said, in all cases, leasing activity in our markets has improved and optimism is improving. Re-entry remains fluid. The third point is that American office workers are back to work at the highest level since the pandemic. In Austin, our newest market is leading the way at 61%, followed by Dallas and Houston. So Texas is really going to be a bellwether, we think, for return to office nationally. The last thing I'd say on this third point is the average occupancy for the top 10 metros in the U.S. is about 40.5% today. A lot of that has been impacted in the last six weeks by Easter, Passover, and extended spring breaks, so that has affected demand, we think. The last point I'd make is that real estate executives that we're speaking to at major companies are almost entirely consumed with bringing people back to work with various programs you've probably read about, Google having concerts at their campus in Mountain View and other schemes like that to bring people back to work. I can go into individual markets if you'd like, or I can stop there.
Nick Yulico, Analyst
Yes, that's great. I have a follow-up regarding San Francisco. Can you share how traditional office leasing demand is performing and what employers think about Silicon Valley? They already have some campuses there, and it seems that tenants are able to work remotely or go to the office in Silicon Valley instead of San Francisco. I've heard reports of at least one company stating they could relocate employees to the Valley. I'm curious about the latest developments in leasing in San Francisco.
Rob Paratte, COO
As of yesterday, VTS reported that tours in San Francisco increased by 23% from February to March. Year-to-date leasing in the city reached 732,000 square feet, with 611,000 square feet being Class A and 121,000 square feet being Class B. A broker mentioned that if you have commodity space, you’re not busy, but if you have quality space, you're quite active in San Francisco. Sublease space has decreased to approximately 6.5 million square feet from a peak of 9.4 million during the pandemic, which is a positive sign. John mentioned that BART and Bay Bridge crossings are showing upward trends, and weekly data has increased over the past three months, indicating a rise in street activity. The atmosphere in San Francisco has changed significantly in the last three weeks regarding the number of people on the street and in lobbies. Regarding Silicon Valley, we desire higher physical occupancy in both San Francisco and Seattle, which currently sits around 24% to 25%. While Silicon Valley is very busy, real estate executives are discussing plans for San Francisco and are starting to bring employees back to work, although this hasn’t led to significant movements from big tech yet. Overall, many in the industry are concentrating on getting people back into the office to better gauge demand.
Nick Yulico, Analyst
Thanks a lot. Appreciate it.
Operator, Operator
Thank you. Our next question today comes from Bryan Spun from Evercore. Please go ahead, Bryan. Your line is now open.
Unidentified Analyst, Analyst
Hi, thanks. So for the new development in Austin, there's obviously a lot of development going on there. Can you maybe just walk us through what your pitch is for prospective tenants there? John, you mentioned the light rail. Just curious what's the immediate amenity base like there? And what's the walkability to the domain?
John Kilroy, CEO
Rob, do you want to take the pitch part. We're in the process of making.
Rob Paratte, COO
Yes. So we're really excited about the Stadium District. The domain, clearly, domain proper gets a lot of attention because of the shopping mall that surrounds the existing office buildings. But the Stadium District is an up-and-coming neighborhood with a huge amount of residential coming in, as John pointed out in his comments. The light rail is going to be a major impact in connecting the whole area of the domain, as well as the Stadium District to downtown. And we actually see it. I always like to look at marketing and how we play off a different market in different ways. We actually see the Stadium District as a real opportunity for new amenities and improved amenities, less congestion in and around our project. There are some competing mixed-use projects that are relatively close in timing to ours that will include hotels, restaurants, and that sort of thing. We think that with the stadium there and their food and beverage programs, their conference centers, that kind of thing, what we're planning on site, as well as what's happening in the immediate neighborhood, we're going to have a very vibrant market there. And keep in mind, from when we put shovels in the ground to deliver space, it's probably a two-year process. So things are changing quickly in that submarket.
John Kilroy, CEO
The light rail line will be approximately 32 miles long and will feature nine stations, including the McKalla station at the stadium, which is expected to be finished in the fall of 2023. The project is fully funded and will stretch from downtown through the domain up to Northwestern Austin, with completion anticipated around 2025, according to the city. There may be some delays, but I'm not certain.
Unidentified Analyst, Analyst
Got it. And then just in the Austin CBD, Rob, can you talk a bit more about the leasing efforts at Indeed Tower? When do you think you'll get the remainder of that building leased? And what are you hearing from the tenants, prospective tenants there?
Rob Paratte, COO
Sure. So the CBD, as John mentioned in his remarks, Facebook took over 650,000 square feet recently. That deal, by the way, just to give color, had been in discussions for almost four years. So that is not something that just popped out of nowhere; it took a long time between the pandemic and Meta finally putting it in writing. TikTok took the balance of the largest Class A space in that submarket. We're averaging about a tour every seven to 10 days. We have a handful of tenants that are over 100,000 feet each that we're in discussions with, looking at the space. The space, if you've not been to it, you should see it. It shows extremely well. We've got a beautiful lobby, as you'd expect from a Kilroy project, beautiful, very clear, light and air views around almost all floors of the project, and our floor plates are 33,000 feet, hitting multiple tenant types, whether it's professional services or tech. Just to give a little more color, the tenants we're talking to are a mix of professional services and technology. So it's nice to be able to fish in a couple of different ponds, if you will.
Unidentified Analyst, Analyst
Rob, you pointed out how we're positioned with regard to square footage we have left versus the other Class A process in the market that are available in the same time frame?
Rob Paratte, COO
Right. So we have the largest contiguous block of Class A space, trophy space, in the market right now and for the foreseeable future. Therefore, we have over 200,000 feet right now that we're marketing. As I said earlier, we've got more interest than we have space. So we're really focused on trying to do the right thing for the asset. I'd also say, without getting into our competition and who they are, that some of the transactions that have happened before we closed on Indeed and during our lease-up of Indeed have been at rates that we're just not going to transact at those levels.
Unidentified Analyst, Analyst
Great. Thanks very much.
Operator, Operator
Thank you. The next question today comes from John Kim from BMO. Please go ahead, John. Your line is now open.
John Kim, Analyst
Thank you, good morning. John and Rob, you provided examples of tech companies leasing space and the return to office as significant factors. However, it's worth noting that the NASDAQ has dropped 20%, with some companies experiencing declines of 60% or more. Has this affected leasing activity or led to an increase in sublease space being offered by these companies?
John Kilroy, CEO
Take that, Rob.
Rob Paratte, COO
Yes, this is Rob, John. We're not seeing that. If you look nationally at the requirements that are in the office sector right now, even in Midtown Manhattan, it's quite robust from banks and companies. We're just not seeing a letup. I would say particularly in Seattle and Bellevue, where there are some things going on that have not signed yet. There's going to be more happening up there. San Francisco activity is picking up, as we've said, and larger deal sizes are picking up. We're just not seeing the half-million-foot requirements that we saw in 2018 and 2019 yet. As I've said in previous calls and investor meetings, hiring has continued unabated for all these tech companies. It is a fact that they’re going to need office space to fill those employees. I think one interesting point was an interview with Eric Schmidt, the former CEO of Google, where he's quoted saying, 'I don't know how you build a great management team virtually; virtual tools are not the same as the informal networks that occur within a corporation.' So we're seeing continued interest in San Francisco and in the other markets where this top-tier talent pool is available.
John Kim, Analyst
Okay. And looking at your office lease expirations, it's very manageable. In 2023, you have 11% of your leases expiring by square footage. What's a reasonable expectation of where this goes to by the end of the year as far as what you address this year?
Rob Paratte, COO
I don't want to predict, but I can tell you we're in discussions on the bulk of the space and a lot of the interest came up starting in February. I'd remind everyone we still had Omicron floating around in January and early February. So a lot of the conversations we're having on our '23 expirations started in earnest in February; a few of them were before. But we're under discussions right now with the bulk of it. I feel confident I will be successful.
John Kim, Analyst
Thank you. Thank you, John. Our next question today comes from Jamie Feldman from Bank of America. Please go ahead, Jamie, your line is now open.
Jamie Feldman, Analyst
Thank you for your comments on the strong FAANG requirements. Could you elaborate on the smaller tenants in the market, especially since it seems like venture capital is beginning to slow down? Additionally, your leasing volume for the quarter dropped significantly below your average from the previous four quarters. Can you identify any specific reasons for this? And do you anticipate improvements in the future?
Rob Paratte, COO
Yes. Let me start with the latter question first, Jamie. I would have loved to announce deals that we have in the works for the first quarter, but we're just not going to do what I would call silly things to get a transaction done. We always maintain our discipline and negotiate the best deals we can for ourselves, but also try to make it mutually beneficial. We are close on some things. John gave you the number at 350,000 feet. Those are late-stage discussions. I don't want to give more color on that, but more to come, I feel confident about. The first question was, I'm sorry, what was that? It was on...
Jamie Feldman, Analyst
Just - I mean, you talked about FAANG.
Rob Paratte, COO
Smaller? Yes, smaller. It really depends on the market. We currently have a 6,000-foot transaction in Bellevue that should be signed any day now. On the smaller side, Hollywood has been slow for tenants looking for 30,000 square feet or less. In San Francisco, there is significant activity for spaces ranging from 15,000 to 30,000 square feet. The ideal tenant size in the central business district is about 15,000 feet, and tour activity has been strong, particularly from tech and professional services. There has not been a slowdown; in fact, in the past six to seven months, we've actually seen an increase in smaller tenants taking up space, many of which involve relocations to improved spaces in San Francisco.
John Kilroy, CEO
I'd like to add that we don't have any space available in San Diego. We have 2100 Kettner, but we're not looking to make smaller deals there, except to backfill larger tenants that we're working with in the Del Mar area, for example. There is significant demand from smaller tenants for high-quality space in that area, but we simply don't have any product to offer. It's a valid point you raised, Jamie, as smaller spaces have lagged in many regions. For instance, in Austin, we're seeing a surge in financial services, D.C.-based companies, law firms, and others of varying sizes. That market is thriving and attracting many new businesses looking to establish themselves in Austin. Smaller tenants have faced challenges in this area, but that is starting to change. Overall, as Rob mentioned regarding the situation in San Francisco, about 85% of the leases signed in the first quarter involved high-quality spaces. Ultimately, it's all about securing high-quality real estate in prime locations, and we believe we perform well in that regard when we analyze our portfolio.
Jamie Feldman, Analyst
I appreciate it. But when you think about a pullback in VC funding, whether it's life science or the tech, I mean, how exposed do you think your portfolio would be to that and delayed decision-making by those types of tenants or even failures, but those types of tenants.
John Kilroy, CEO
It's hard to predict. There have been all-time highs in VC funding, and it's backed off a little bit. Still, if you look at it over a ten-year period, it's still on track to be one of the best years ever. I don't know how to predict that. We obviously talk to some of our VC friends about what they're doing. They all seem to be very busy, but I can't predict that, Jamie.
Eliott Trencher, CFO
And Jamie, this is Eliott. Maybe just to add on to that, and John's point, when we look at the trends in VC funding, you're right in that they're down from 2021. But I think it's important to keep the context of 2021, which was a record year of VC funding by a multiple of two. If we're down a little bit in 2022, we're still at the second-best year by a meaningful margin. We think that's a healthy environment for companies even if it wasn't as good as last year because their availability of capital is still quite strong. So when we take a step back and look at kind of the bigger picture trends, as John mentioned, things are still in pretty good shape.
John Kilroy, CEO
Could you discuss the types of bids you are receiving for assets and describe the buyer pool? Additionally, what are your thoughts on asset quality? Do you expect Kilroy to continue selling assets to enhance portfolio quality in the coming years? Well, Eliott, do you want to take on what we're seeing in the way of asset sales and so forth, and I can take the quality afterward?
Eliott Trencher, CFO
Sure. So Jamie, similar to kind of on the leasing side, I think that on the capital markets, just with the change in interest rates that has happened over the last six weeks or so, the volume of asset sales has sort of slowed as everyone tries to figure out where things are going. It's interesting because while the 10-year, I don't know where it is say, but call it high twos on a relative basis, this is sort of where we were in 2018. It's not the absolute level of where the tenure is that is getting people to pause; it's just the volatility. Volume has not been as high as it's been, even at the end of 2021. In terms of the trades that have happened, they're still plus or minus in the same ballpark as where asset values were at the end of last year, so volume is a little bit lighter, but asset values are plus or minus similar.
John Kilroy, CEO
On the quality side of things, you asked whether we expect our quality to improve even further? Well, I think most people know we probably have the highest-quality portfolio of anybody in the country. So we're in pretty good shape on the quality spectrum. In terms of what we sell, does that materially impact the overall quality? Maybe a little bit. Our development is all top-tier quality. I don't know how to say that. I don't want to signal exactly which buildings we're thinking of selling. But we're very focused on where to be and physicality, how is the building set up to perform for the long term? Whether we can make any more value by owning it versus selling it and using that for alternative investments. That's going to continue to be the way we operate the company. From a qualitative standpoint, even though some of the assets we might have might be somewhat older, they've all been, by and large, gone through major renovations over the last few years. So I think we're positioned at a very high mark and higher again than I think anybody else on a portfolio basis as to the quality standard. So I can't give you much more than that, Jamie.
Jamie Feldman, Analyst
Yes. I guess maybe a better way to ask it is just do you feel like the low end of the range of what you'd want to own long term has changed through the pandemic? I know you're always recycling, but could you kind of raise the bar on the long-term keepers?
John Kilroy, CEO
I would affirm that, yes. It has been extensively discussed by many, including the brokerage and real estate sectors, that the shift towards high-quality assets has been accelerated by COVID. We identified this trend over a decade ago in various discussions that I or others from Kilroy participated in at industry events. We have been signaling this long before now. I even coined the phrase 'not your father's office space,' which has been widely adopted by our peers. Our goal is to set ourselves apart from other providers in multiple ways, which you've observed during your tours of our assets. We focus on differentiation with the intent to attract and retain tenants, creating long-term value rather than just securing short-term deals. For instance, the approximately 300,000 square feet we converted in San Diego to life science spaces were all well-suited for such transformations. These buildings had the necessary structural features and specifications for life science use, allowing us to make these conversions at relatively low costs. We consider not only the current use of our spaces but also their potential for future adaptation, taking into account the lifespan of existing tenants and market factors. I believe you will see that as we maintain our high-quality portfolio today, it will become even stronger in the future.
Jamie Feldman, Analyst
Okay. Thanks.
Operator, Operator
Thank you. Our next question today comes from Manny Korchman from Citigroup. Please go ahead, ma'am, your line is now open.
Manny Korchman, Analyst
Hey, everyone. Good afternoon. I know you don't include acquisitions in your guidance, but are you actively looking for acquisitions in the life science side? If so, are those strictly land deals? Or would you look at other assets to either convert or add to your life science platform?
John Kilroy, CEO
I'll take that one. This is John. We look at everything in our markets, but we haven't found any assets we want to convert to life science that make sense for us. As I've mentioned before, while it's possible to convert many buildings to life science, the key questions are whether people will want to be there and if it's financially viable. We don't understand how some of the current projects generate profit. There are many smart people in the field who might have better insights regarding specific buildings than we do. However, we haven't encountered anything available for purchase. We assess everything, especially in our own portfolio that is in prime locations where demand exists and the buildings are suitable for conversion. When we undertake conversions, we believe we can achieve greater scale. Some projects are currently occupied and not immediately accessible. We have always appreciated development, whether for office or life science, because we can create best-in-class assets that improve over time as interest rates and demand increase. Our emphasis is on development, presenting users with attractive properties that include desirable amenities and features. While we are more focused on development, we are still open to acquiring existing life science properties or converting current assets, although we haven't found anything that aligns financially with our goals.
Manny Korchman, Analyst
Thanks. And are you only looking in your existing markets against specifically on the life science side? Or are you looking for new markets there as well?
John Kilroy, CEO
We look at a lot of different things, but I'm not going to tell you any particular markets we're looking at because I don't want competitors to know. I can tell you there's nothing active on our radar about life science in a different market today.
Operator, Operator
Thank you. Our next question today comes from Caitlin Burrows from Goldman Sachs. Please go ahead, Caitlin, your line is now open.
Caitlin Burrows, Analyst
Hi there. Maybe just continuing on the life science topic. We've heard that life science development construction costs and lead times are being extended as delivery of key materials, systems, and generators are taking longer. So are you seeing any impact to your in-process life science projects or your plans at Summit Santa Fe?
John Kilroy, CEO
We have GMP prices and delivery schedules established for all projects before we commence. While this sets a solid foundation, unexpected challenges can arise. Our construction development team's risk management is highly proactive in addressing these issues as they occur. It's evident that construction costs are increasing, and lead times are becoming longer, which could pose challenges for many developers. For those with significant land holdings and urgent development timelines, this could create difficulties. However, we don't feel pressured to develop immediately; we can afford to pause and assess the market. This evaluation considers not only demand but also construction costs. Currently, in Bellevue, construction expenses have risen more significantly than in many other areas. Companies like Amazon are undertaking substantial projects, creating high demand for contractors and subcontractors who are quite busy. We have a development site in that area, but it's still a couple of years before we can initiate construction. Even if we had everything ready to go today, we would choose to hold off, waiting for conditions to improve and for pricing to stabilize. To summarize, we are diligent in our approach, never start projects without a GMP price, and conduct thorough due diligence on our contractors, which our stakeholders have come to expect from us. We maintain a rigorous process, especially in today's environment.
Caitlin Burrows, Analyst
Got it. Okay. Earlier, you mentioned a significant vacancy in San Diego, and I was wondering if you could share information on leasing activity or expectations for that vacancy that arose this quarter at one of the Sabre Springs buildings.
John Kilroy, CEO
Sure. Do you want to take that on?
Rob Paratte, COO
Sure. So just to give some color, the I-56 and I-15 corridor is the area where the San Diego vacancy is, but that is a corridor that has been, I would say, evolved to where you see life science activity happening. There's a 500,000 square foot life science company that just signed a lease out in that corridor on 15. As you go north, you have several of the FAANG companies in the market. We've been pretty engaged with a variety of companies on the space we have. I have nothing to announce as far as we're going to sign something imminently, but the activity is good. The space shows very well, and actually, the location is oriented toward I-56 and I-15, and it's probably the first stop as you go into that corridor. So we're going to do fine there. We just need to get big tenants making decisions.
Caitlin Burrows, Analyst
Thanks.
Operator, Operator
Thank you. And our next question today comes from Vikram Malhotra from Mizuho. Please go ahead. Your line is now open.
Vikram Malhotra, Analyst
Hi, thanks so much for taking the question. Just wanted to get your thoughts on what this quality divide in, say, San Francisco or the Bay Area may eventually do to where rent differentials exist between these two groups and maybe even values? And then is that an opportunity for Kilroy to maybe look to redevelop value-add property and create sort of an asset longer-term that fits in the portfolio?
John Kilroy, CEO
Yes, let me start with that. This is John. There's a lot that needs to unfold before we can understand how people will adjust to returning to work and how space usage will evolve, which will impact remodeling and demand for spaces, as Rob mentioned. It's challenging for us to act on potential redevelopment sites right now since we have a lot to manage in terms of leasing activity. We're focused on some buildings we want to sell and are active in Austin, aiming for growth in that market. We're working on obtaining entitlements for various uses to ensure we have many options. Currently, we are not seriously considering the Valley for acquisitions of companies or properties for redevelopment, though we always keep an eye on potential opportunities. The quality divide I've previously mentioned has become more significant, and the trends accelerated by COVID have only reinforced this. I wouldn't want to hold onto commodity office space or own properties in locations that lack appeal. It feels like a losing proposition, and I anticipate many will face difficulties. Rob can provide more details about the demand differences between high-quality and commodity spaces. Rob, perhaps you'd like to share your thoughts on that.
Rob Paratte, COO
Sure. Just to add color to what John was saying and I'll talk about San Francisco and everyone likes to hear about the city. Class A trophy rates are higher right now than they have been pre-pandemic. Again, that's Class A view space, and there's very little of it. It's right now less than 8% vacant in that submarket. By contrast, and let me point out two things: there's sublease space, and then there's direct space, which is also a differentiator. Right now, there's probably a $15 a foot gap between Class A rates and what I would call Class A minus to B rates. That gets further impacted when you look at 43% of the space that is sublease space on the market, which has a term of about 2.5 years.
Vikram Malhotra, Analyst
That's interesting. Yes. We just see where eventually the gap settles, and what this means for the value gap as well versus sort of pre-COVID level. Just maybe one more for Eliott. Can you just clarify for us two things on the expense side? Overall expense, any changes in the OpEx outlook for the balance of the year? Any puts and takes there? And remind us on the interest expense side. I know there were changes you outlined, but I just want to make sure what you're factoring in for just a higher rate environment?
John Kilroy, CEO
So nothing on the OpEx side to think about. I think you may be referring to how it was up a little bit sequentially, and our reimbursements were correspondingly up a little bit. There's really no notable change there. On the interest expense side, we have no variable-rate debt. We have no maturities for the balance of this year or next year, as we said, until the end of 2024. There really aren't a ton of moving pieces there. As I alluded to earlier, our cap interest is going to be a little bit higher. I think last time we gave a range of $70 million to $80 million, so we're probably trending towards the higher end of that range. That's a function of our Austin project that we acquired, but that's really the only moving part for this year.
Vikram Malhotra, Analyst
Okay, great. I was wondering if you have any information on the sublet rates in your own portfolio, considering we know what the rates are across the city or the Bay Area. Do you currently have anything available for sublet?
Rob Paratte, COO
There's nothing material to report. The largest sublease in our portfolio has been taken care of, which was at 350 Mission, with both Yelp and Sephora moving into that space. This highlights companies transitioning from lower quality, less desirable locations to a more competitive Class A asset. The asking and transactional rates for sublease spaces vary widely based on the sublessor's motivation. Generally, sublessors are looking to cut costs and typically won't wait for an additional $5 or $10 per square foot if they're eager to fill the space. In many cases, they have already written it off.
Vikram Malhotra, Analyst
Great. Thanks so much.
Operator, Operator
Thank you, Vikram. Our next call comes from Blaine Heck from Wells Fargo. Please go ahead, Blaine, your line is now open.
Blaine Heck, Analyst
Hi, great. Thanks. Just one for me here, probably for Rob. Can you give any more color on leasing progress at KOP Phase 2? I know you guys still have a lot of time until completion. But are there any conversations you guys are having now that I think that project has gone vertical?
Rob Paratte, COO
Yes. Hi, Blaine, it's interesting. Similar to Austin, we're doing presentations; Jonas Vass, our Head of Construction and Development, and I are doing presentations every seven to 10 days with users. Tour activity has really picked up pretty dramatically in the last five weeks. Some of that activity involves an entire building in one case, and some of it's just a floor, multi-tenanting scenarios. Demand in the market still remains strong at 3.5 million square feet, and activity for space that's ready to go, meaning lab space that's built out or that's further ahead of us in the construction cycle is continuing to lease and do well. We think it will continue to increase over the next summer.
Blaine Heck, Analyst
That's helpful. Thanks.
Operator, Operator
Thank you. Our next question comes from Pedro Cardoso from TCD. Please go ahead, your line is now open.
Unidentified Analyst, Analyst
Hi. Thanks for taking the question. Can you guys a quick one for me. Can you just please comment on current physical occupancy and how that's been trending? I'm just trying to get a bit of sense of return to the office trends. Thank you.
Rob Paratte, COO
This is Rob Paratte. I'll address that. As I mentioned earlier, let's begin with the physical occupancy in Austin, which is leading at 60%. San Diego is around 50% at our One Paseo project in Del Mar, although you could argue it’s closer to 60% based on the past year. Los Angeles, San Francisco, and Seattle are generally in the 25% to 30% range, depending on the submarket. It's risky to generalize the overall market. However, as John noted, tech companies are making a concerted effort to bring employees back to work, while also being cautious not to lose the talent they have hired. Therefore, they are taking a gentle approach to this transition.
Unidentified Analyst, Analyst
Got it. That’s really helpful. Thank you.
Operator, Operator
Thank you. Our next question comes from Daniel Ismail from Green Street. Please go ahead, your line is open.
Daniel Ismail, Analyst
Great. Thank you. Just another follow-up on Kilroy Oyster Point - Oyster Point Phase 2. I'm just curious how the underwritten yields there have changed. You mentioned earlier on the call that the fixed cost to develop the project. But I assume rents have run pretty significantly since you guys broke ground.
John Kilroy, CEO
Yes, this is John. Rents have gone up. They're at all-time highs. They're quite a bit higher than we forecasted. I'm unwilling to say what we think our new yields are going to be, but I think we're going to do better than what we initially felt we could achieve. More to come, but you're right; the rents are up. I don't recall exactly what we underwrote to, but they're up somewhere in the neighborhood of $10 or more per square foot per year.
Rob Paratte, COO
Yes. If you look at our Cyto and Stripe deals, rents have increased by over 25% since those agreements were made. There has been no slowdown in the asking rates, and they continue to rise.
Daniel Ismail, Analyst
Got it. That's helpful. I have a question out of curiosity. We've noticed that life science rents in San Diego have increased significantly in the past few quarters. Do you believe that life science rents in San Diego will eventually align with those in South San Francisco and Seattle, or will there remain a difference between these markets?
John Kilroy, CEO
I think in some of the newer deals I've heard about, they're exceeding $7 triple-net. That's around $84 in rates in South San Francisco, and in some instances, they are even higher. However, the rates may vary as you move further away from UTC and Torrey Pines, potentially resulting in lower rates. We've estimated considerably lower for Santa Fe Summit and I don't anticipate much of a difference. I'm referring to really excellent properties in prime locations; the market will certainly differentiate between those that are not as good or well-located. You should take my comments with a grain of salt.
Daniel Ismail, Analyst
Got it. Thanks, John.
Operator, Operator
Thank you. This concludes today's Q&A session. I'd now like to hand the call back to Bill Hutchison.
Bill Hutchison, Senior Vice President of Investor Relations
Well, thank you so much, Emera, and thank you, everybody, for joining our call today. We appreciate your continued interest in KRC. Have a good day.
Operator, Operator
This concludes today's call. Enjoy the rest of your day. You may now disconnect your lines.