Kilroy to Tread Silicon Valley With Care

By Sharon Simonson

State Highway 237—which connects Silicon Valley at Mountain View to the southern stretches of the East Bay—has seen a flurry of commercial leasing, development and acquisitions as the regional economy has rebounded.

Southern California behemoth Irvine Co. and San Francisco’s Jay Paul Co. are pursuing big speculative office developments on the corridor, even as tenants including Dell Inc., Microsoft Corp., Flextronics International Ltd. and Polycom Inc. are settling into new 237 digs.

With the construction start of the $1.2 billion 49ers football stadium a mile south of where Highway 237 passes through Santa Clara, one might argue that a new Silicon Valley center of gravity is exerting its pull. The 1.85-million square-foot stadium to seat 66,000 people has a 26-month construction horizon. It is to host up to 25 events a year including 10 professional football games, and is competing for the 2016 Super Bowl.

Now comes Kilroy Realty Corp., the Los Angeles-based property trust that has bought more than two million square feet of Bay Area buildings in the last two years—most of them in San Francisco’s South of Market district. On May 9, Kilroy said that it had acquired its second Silicon Valley project, 690 E. Middlefield Road in Mountain View, which is also adjacent to Highway 237. Kilroy said it would build a $200 million campus for Synopsys Inc., a deal that the previous owners struck before the sale.

But Kilroy Chief Investment Officer Eli Khouri said it would be a mistake to interpret the buy and development agreement as just another bet on Highway 237. Kilroy likes the Mountain View address and that the site hugs what is generally considered central Silicon Valley. “I would not be as comfortable further out on 237, and we like that we have the light-rail connection to Caltrain,” he said.

Mountain View is now Palo Alto’s equal as a commercial property hub, primarily because of Google Inc.’s explosive growth though also because Palo Alto is such a difficult place to develop commercial buildings, Khouri said. Kilroy is not “exclusively transit-oriented” when it considers its real estate but believes that good transit access represents a rising tenant preference. And, unlike Jay Paul, Irvine and The Sobrato Organization, Kilroy has no immediate plans for speculative development in Silicon Valley, though the company has done speculative work in its past.

“I am concerned that there is a fair amount of development in Silicon Valley in me-too locations. For us to buy land and build spec, it would have to be a site with superb long-term attributes, and those are few and far between. I am also cautious in Silicon Valley about extrapolating the last couple years’ demand growth from where we are,” Khouri said.

Not quite 1.9 million square feet of new construction is underway in Silicon Valley today, primarily in Sunnyvale and Santa Clara, according to a first-quarter report on the office market from Cassidy Turley Commercial Real Estate Services. That sum is made up of 700,000 square feet that Juniper Networks Inc. is building for itself in Sunnyvale near Moffett Towers and 1.2 million square feet of speculative office construction now ongoing, said Gregory M. Davies, a senior vice president for Cassidy Turley in Silicon Valley. It includes the first, 324,000 square feet of The Sobrato Organization’s Campus at Lawson Lane in Santa Clara, the Irvine Co.’s Santa Clara Gateway’s first phase with 447,000 square feet, and the seventh and final tower at Jay Paul’s Moffett Towers with 357,000 square feet, also in Sunnyvale.

The Cassidy Turley count does not include all projects that have been put forward, however. Henry Bullock, founder and chairman of Palo Alto-based real estate investor and developer Menlo Equities, told a Silicon Valley commercial property audience in November that he expected to start speculative development in the first quarter with 435,000 square feet at 3333 Scott Blvd. in Santa Clara. His 30.2-acre site is zoned for 1.3 million square feet, according to the Menlo Web site.

Nor does the Cassidy Turley number include a second Sunnyvale project just unveiled by Jay Paul. The San Francisco developer contemplates another million square feet, also near Moffett Towers. He filed his first documents with the city in early April.

Nor does the Cassidy Turley count include 101 Tech, the North San Jose campus that San Francisco’s Ellis Partners LLC has proposed. Ellis hopes to gain entitlements by September and plans to add 665,000 square feet to complement an existing 291,000 square-foot building, which Atmel Corp. sold and is vacating. The campus would front U.S. 101 near state Highway 87 and is not too far from North First Street and Highway 237.

“In Silicon Valley you have to be thoughtful and careful over the long term, particularly building speculative development—careful about locations, physical quality, functionality and services,” Khouri said. “I think many tenants are at a transition point. If they have to live with substandard product, they will, but they are drawn to state-of-the-art, functional product that serves today’s collaborative workforce approach, and there is much higher demand for transit than there has been, which we believe will persist.”

In the last two years, Kilroy has changed from a Southern California real estate investment trust with all of its properties in Los Angeles, San Diego and Orange County, according to its filings with the Securities and Exchange Commission. It is now a West Coast property owner, expanding aggressively in the Bay Area and Seattle. In the last nine quarters, Kilroy has grown its portfolio by not quite 25 percent, reaching 15.2 million square feet. More than 70 percent of that increase has been in the Bay Area—excluding the Synopsys deal.

The company bought its first Silicon Valley property earlier this spring when it paid $162.2 million for the 374,000 square-foot Menlo Park Corporate Center, a property that is not far from the new Facebook Inc. campus.

Kilroy has developed more than 60 million square feet in its history, including build-to-suits, campus redevelopments and speculative developments, according to the company. That includes work for the aerospace, health care, financial services and technology industries such as Mountain View-based Intuit Inc., an accounting and tax-preparation software company; Hewlett-Packard Co., and satellite television provider DirectTV. The Synopsys campus is its first build-to-suit development in the Bay Area.

Part of Kilroy’s West Coast expansion has included adding on-staff development expertise. Just more than a year ago, it hired Mike L. Sanford to be its vice president in charge of the company’s Northern California region. Sanford is an alumnus of both Spieker Properties Inc. and Equity Office Properties Trust, two former publicly traded real estate investment companies active in the Bay Area. He did development work for both and has recently expanded Kilroy’s project management staff to handle current and future development and redevelopment work. Khouri also has significant development experience.

Khouri was chief investment officer of Spieker, a Menlo Park-based real estate investment trust acquired in February 2001 by Equity Office, a Chicago-based REIT at the time. Equity Office was subsequently taken private by the Blackstone Group, which continues to own much of what was at one time the Spieker portfolio.

The Spieker sale to EOP occurred immediately before the dot-com crash, though it was negotiated for months before its eventual transfer. Asked in early 2011 how the company knew it was time to sell, Ned Spieker, the company’s founder and chairman, told The Registry that no one predicted the dot-com bust—but within the company’s upper ranks sentiment prevailed that rising rents were driving too much development and that the obvious euphoria had to end.

Cassidy Turley predicts Silicon Valley rents for offices and research and development buildings will rise 20 percent this year on the wings of 7.5 million square feet of net absorption, 15 percent next year based on a projected 6 million square feet of occupancy increases and another 10 percent in 2014, when the brokerage projects another 6 million square feet of vacancy declines. Rents won’t regain their 2007 peak until the end of this year and will remain approximately $2 a square foot below their dot-com peak at the end of 2014.

“Post-crisis, things were priced better, and we could be more broadly aggressive. Now I think we are going to have to look harder and at a much larger number of potential opportunities to find ones that we can do profitably,” Khouri said.

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