Kilroy Says: Continued Strong Demand for Development

Bay Area Council, San Francisco, Bay Area, East Bay

By Sharon Simonson

Kilroy Realty Corp. has moved an estimated 70 percent of its office portfolio to match what it says are new norms for workspace, with an emphasis on open floor plans, worker density and sustainability.

100 First Plaza
A Kilroy Beacon: 100 First Plaza

A trend that began with the tech industry is moving beyond that silo, John Kilroy, company president and chief executive, said May 1.

All of Kilroy’s new buildings will be rated under the Leadership in Energy and Environmental Design program as well as Energy Star rated by the federal government. Buildings not equipped with these attributes and the fortitude to withstand heavy use over many hours a day won’t lead the marketplace any more, he said.

“We are seeing it in all industries, not just the tech sector. It is no longer just a 9 to 5 workday. We are fusing the line between work and play,” he said. Going against these trends means confronting the echo boomers, the largest generation since the Baby Boomers and the work force that will often replace them.

“It is the most amazing transformation of office space in 40 years,” Kilroy said. “We are not going back to cubby holes and private offices. Even lawyers and financial entities are going toward a more open environment.”

If the market needs proof that much of the existing stock doesn’t fit, it need look no further than the demand that the company is seeing for its new state-of-the art buildings, he said. That includes appetite both for new build-to-suit space and for its development pipeline, which includes 333 Brannan St. in San Francisco with 170,000 square feet and Redwood Towers in Redwood City, where it plans 300,000 square feet.

“Last year was certainly an extraordinary year in terms of pre-lease development opportunities, and this year, we are seeing an increase in the number of companies considering new campuses with several large RFPs currently in the market for sizable build-to-suit requirements both in Northern and Southern California,” he said.

Kilroy is in mostly early stage negotiations with companies seeking to lease 1.7 million square feet of new office space within Kilroy’s nearly three million square feet of future and potential development, he said: “The ability to support density and sustainability are essential to how tenants chose projects today.”

Like Boston Properties and other real estate investment trusts including San Francisco-based BRE Properties Inc., Kilroy is disposing of assets that no longer meet its long-term strategy. That includes properties in and around Orange County and San Diego, said Chief Investment Officer Eli Khouri. Those properties are selling based on capitalization rates that range from the low 5 percent range to the mid-6 percent range.

The company hopes to raise $150 million from the property sales and another $75 million from land sales. San Diego is its largest market with 5.2 million square feet of buildings; Orange County its smallest, with less than 500,000 square feet.

The company has four build-to-suit projects underway, including buildings for Inc. in San Francisco and Synopsys Inc. in Silicon Valley. It expects to invest $810 million in the four and earn a yield in the low- to mid-7 percent range, he said.

“San Francisco remains in a class by itself,” said Jeffrey C. Hawken, executive vice president and chief operating officer.

Developers have announced an estimated two million square feet of new development projects in San Francisco, Kilroy said. The company expects to compete in that environment at least in part because of its low cost-basis.

The company reported funds from operations, a common measure used by real estate investment trusts, of $49.1 million in the first quarter, up from $33 million in the same time a year ago. It reported a net loss of income available to common stockholders of $900,000 for the quarter, compared to net income of $67.5 million in the first quarter of 2012. The 2012 results included $72.8 million in net gains from property dispositions.

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