Kilroy Realty’s first quarter of 2017 earnings call delivered a number of news items about the west coast REIT’s operations and activities. The company is healthy, it is active across all four major markets where it owns properties, and it remains optimistic about its opportunities and disciplined in its growth and ambitions.
In the Bay Area, where now the largest chunk of Kilroy’s portfolio resides, the company has made strides recently by leasing the full 314,00 square feet of its 100 Hooper project to Adobe. The design and document management services technology company announced in a release with Kilroy in November of 2016 that it would be taking 207,000 square feet of the property. In yesterday’s call, John Kilroy, the chief executive of Kilroy Realty, announced that in February of 2017 Adobe took the remaining space in the development. The total square footage of the property is 400,000, and the remaining 86,000 square feet is PDR space that is expected to be leased within 12 months of completion, which is projected to be in the third quarter of 2018.
While most of the news for Kilroy has been surrounding their activities in San Francisco, the company did acquire in December of 2016 two building in Palo Alto’s Stanford Research Park for $130 million, one of which is leased to the now defunct life science darling Theranos, Inc. One of the analysts on the call asked about the company’s exposure to that lease, which John Kilroy views as an opportunity. “We’re assuming they stay in occupancy and pay rents through the end of the year. We believe that building is leased at well below market,” he said. “But we think we’re in a very good position with regards to that market, that asset and there is prospective upside potentially if something should happen to them.”
The biggest news, perhaps came from the company’s decision to reposition the 700,000 square foot development known as The Exchange on 16th in San Francisco’s Mission Bay neighborhood. The LEED Platinum designed development is presently under construction, and Hathaway Dinwiddie is the general contractor. The Rios Clementi Hale Design Studios-designed project consists of two six-story and two 12-story buildings and carries a development cost of approximately $485 million. To date, the company has not announced any leases at the property and perhaps because of that has made the decision to reposition the development to appeal more to life science tenants. In the process, Kilroy is expanding the development by 50,000 square feet and adding another $75 million in cost, making the development now $560 million.
On a per square foot basis, that comes to $746, which, according to Kilroy, is a cost structure well below the $1,000-plus per square foot price where some recent transactions have been selling. “In terms of the cost structure, at $746, you can compare that to recent sales here in San Francisco of Class A, newer product. It’s been well north of $1,000 a square foot, $1,100, $1,200 or more. We think we have a pretty great cost structure and well below what other things are trading at,” said John Kilroy.
The larger issue on which some of the callers pressed the Kilroy executives was if this was a sign of the market slowing down, and if the transition implied a downward direction in the near-term prognosis of the industry. “We have strong interest in the project from a variety of tech and life science tenants and remain confident that The Exchange will be largely leased by warm shell completion in the second quarter of next year,” said Kilroy.
“The demand remains healthy and consistently split across life science and tech,” added Tracy Murphy, Kilroy’s executive vice president of life science and Northern California who recently joined the organization from BioMed Realty. “We have a healthy uptick in tour activity as a result of the vertical nature of construction at this point, but we feel good about it in our ability to accommodate either user group.”
In Mission Bay, The Exchange is the only game, said Murphy. The neighborhood is San Francisco’s largest life science cluster, and it is almost entirely leased. Murphy referenced a number of subleases that were almost immediately taken as they became available. “And so there’s nothing in Mission Bay, and the next competitive option would be whatever comes in South San Francisco, but it’s years away, so it remains to be completely tight on the supply side,” she said.
And this sentiment carries across the organization as it pertains to the general market conditions in the Bay Area; Kilroy and team remain bullish on the region’s prospects. One analyst asked what impact the recent news of people moving out of the region may mean for the market or Kilroy’s business in general, and John Kilroy’s viewpoint reflected his experience with another development the company has in San Francisco, the Flower Mart. “We’ve got more than half a dozen major technology companies that are wanting presentations, wanting detailed information, some of which we’ve met with in connection with their long-term plans,” he said. “So I don’t know. I read all the stuff, and then when I see what’s going on, you look at the expansion that we’re seeing within our portfolio, companies like App/Dynamics as an example (the company nearly doubled its lease from 67,000 square feet to 150,000 square feet in San Francisco), and all these different companies that just keep expanding. It feels good.”
This month, Riot Games, whose majority owner is Tencent, China’s largest internet company, more than doubled its position at Kilroy’s Westside Media Center in Los Angeles.
As of April 26, 2017, Kilroy’s stabilized portfolio was 95.7 percent leased.
“Our real estate markets are among the most dynamic in the United States today,” said John Kilroy in a statement. “They are the breeding grounds for some of the most innovative companies in the world, and magnets for new creative talent. Large, established companies continue to expand their presence here, while enterprising start-ups seek to establish a foothold.”
The quotes above were sourced from a transcript provided by Seeking Alpha.