KILROY REALTY CORP Q4 FY2024 earnings call

Strategic Overview and Quarterly Highlights - Strong end to 2024 with outperformance in financial results and material acceleration in leasing activity. - Team worked on senior hires, rethinking processes, completed development projects, addressed non-income producing assets like selling the corporate airplane. - Fourth quarter leasing was highest since Q4 2019 with key deals, and 2024 was highest leasing year since 2019. - Focus on highest quality vacancies and Kilroy Oyster Point Phase 2 as growth drivers. - Assessing future development pipeline, including derisking, accelerating, and maximizing value, with some parcels needing re-entitlement or more work. ### Transaction Market Outlook - Transaction market closed 2024 on positive trajectory with higher deal volume and financing, bias towards smaller deals. - Core capital returning, with core deals in Austin and Bay Area. - Disposition efforts focused on properties where market value doesn't reflect medium-term risk. - Land sales in advanced discussions for two sites expected to generate over $150 million, but guidance doesn't contemplate FFO impacts from such activities. ### Financial Results and 2025 Guidance - 2025 FFO guidance range $3.85 - $4.05 per diluted share. - 2025 average occupancy expected 80% - 82%, decrease from 2024. - Cash, same-property NOI projected to decline -1.5% to -3%. - Overhead guidance $83 - $85 million for 2025. - Interest income expected to decrease from $38 million in 2024 to about $6 million in 2025. - Capitalization of interest for projects like Flower Mart has assumptions for 2025.

In the fourth quarter, Kilroy Realty achieved an FFO of $1.20 per diluted share. Cash, same-property NOI growth was 70 basis points. Occupancy ended the year at 82.8%. Leasing activity was strong with approximately 708,000 square feet of leases signed in the fourth quarter, the highest since Q4 2019, and 2024 was the highest leasing year since 2019. Key deals included a multi-floor lease with Walmart at Skyline Tower in Bellevue and a 274,000 square foot new lease in the San Francisco Bay Area. The highest quality vacancies like West8 in Seattle, 2100 Kettner in San Diego, and Indeed Tower in Austin had 410 basis points of leased occupancy upside. Kilroy Oyster Point Phase 2 received a temporary CO in Jan 2025 and is a growth driver. Revenue contribution details weren't provided with clear percentage breakdowns for each segment, but key segments are office and development-related.

2025 Guidance - FFO guidance range $3.85 to $4.05 per diluted share. - Average occupancy expected 80% - 82%, decrease of ~300 basis points from 2024. - Cash, same-property NOI projected to decline -1.5% to -3%. - Overhead guidance $83 million to $85 million. - Interest income expected to drop from $38 million in 2024 to ~$6 million in 2025. - Capitalization of interest for Flower Mart and other parcels has assumptions with midpoint assuming capitalization ceases at start of Q4 2025.

• Uncertainty in transaction market and elongated closing process for land sales. - Potential earnings implication in second half of 2025 if planning and design efforts for Flower Mart conclude and development unwarranted. - Disruption in Los Angeles due to recent devastation affecting transaction activity in the short term.

Q: Good afternoon and welcome to the Kilroy Realty Corporation Fourth Quarter 2024 Earnings Conference Call. My name is Harry, and I will be your operator today. All lines are currently in listen-only mode and there will be an opportunity for Q&A after management’s prepared remarks. [Operator Instructions] I would now like to hand the conference over to Doug Bettisworth, Senior Director of Corporate Finance. Thank you. You may proceed.

A: 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 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 webcast live on our website and will be available for replay for the next eight 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 a transaction market outlook, and Jeffrey will discuss our financial results and provide you with our 2025 guidance. Then we’ll be happy to take your questions. Angela?

Q: Thanks, Doug. I’m pleased to report on a strong end to 2024, which was capped off by outperformance in our financial results and a material acceleration in leasing activity. In addition, throughout the course of last year, this team worked tirelessly to prepare for the recovery we knew would take hold in our markets, making critical senior hires across the platform, rethinking processes and systems to be more efficient and nimble, successfully completing several in-process development and major repositioning projects, taking significant steps to address our future development pipeline and other non-income producing assets including the sale of our corporate airplane, which closed in the fourth quarter and actively monitoring the market for opportunistic transactions. The Kilroy team has risen to every challenge that has presented itself and the recent devastation in Los Angeles the location of our corporate headquarters is no exception. I have been inspired by the strength and resilience of this team as they work to support our Los Angeles tenants and each other as we’ve collectively navigated a very challenging start to 2025. During the fourth quarter of last year, we signed approximately 708,000 square feet of leases, achieving our highest level of leasing activity since the fourth quarter of 2019, a testament to the ongoing demand for high quality spaces that align with evolving tenant needs. The quarter was headlined by two significant deals. First, we executed a multi-floor lease with Walmart at Skyline Tower in Bellevue, Washington. Our regional team worked creatively to accommodate Walmart’s significant requirement and accelerated timeline, simultaneously executing an early termination with an existing tenant for a portion of the space that Walmart will occupy, addressing a late 2025 expiration and achieving a meaningful rent increase in the process. In addition, we executed a 274,000 square foot new lease in the San Francisco Bay Area with a global technology company that is the subtenant occupying our largest 2026 expiration. Over 70% of the square footage for this expiration has now been addressed through the lease signed this quarter and a 157,000 square foot lease signed with the same tenant in the fourth quarter of 2023. This execution combined with the SAP renewal in Bellevue, Washington announced last quarter underscores both the proactivity of our team as it relates to addressing our 2026 lease expiration and the increased willingness of tenants to engage and make long-term commitments related to their space needs. Given historically low levels of new supply and increased workplace attendance requirements taking effect, our markets are demonstrating important signs of sustained recovery and we expect these trends to continue to accelerate over the next several years. Kilroy has a number of unique opportunities to capture this growing momentum as we executed over the course of this year. One particular area of focus is the embedded upside inherent in our highest quality vacancies, specifically those concentrated in recently developed or repositioned assets including West8 in Seattle, 2100 Kettner in San Diego and Indeed Tower in Austin. These properties set the standard for quality, functionality and market leading amenitization, ideally positioning them within their respective markets. Vacant space at these assets alone represented 410 basis points of leased occupancy upside at year end, highlighting an exceptional source of future growth for the company. And while not reflected in our occupancy statistics until early 2026, the second phase of Kilroy Oyster Point in South San Francisco will be a substantial growth driver for the company in the coming years. The project received its temporary certificate of occupancy in January 2025 following some slight delays in municipal approvals and is now fully ready to welcome tenants. The spec suites, conference facilities, food and beverage offerings, and outdoor meeting and event spaces set this project apart from competitive supply in the market and are driving constructive conversations with several life science and office users. While the environment in South San Francisco remains highly competitive, we are convicted in the quality of what we’re delivering in Oyster Point and the long-term success of this project. As discussed on prior calls, we continue to proactively assess our future development pipeline and are executing on various programs to derisk, accelerate and maximize value realization for our shareholders. We expect to continue to hold certain parcels such as the land associated with future phases of Kilroy Oyster Point as our current program continues to represent the best path forward. In other cases, including some of our sites in Southern California, it is clear that the path to maximizing value will be a full re-entitlement to an alternative use such as residential, and we’re focused on defining the execution path that will best balance our desire to maximize proceeds with accelerating the timing of monetization. In still other cases, such as with the Flower Mart parcel in San Francisco, the path to value maximization will require more work and exploration. The original plans for the Flower Mart were created against the backdrop of a very different market environment and contemplated 2.3 million square feet of primarily office space to be supported by significant infrastructure investments in the site which limit the ability to face construction. Our team is actively working to create additional optionality for this project that will allow us to be responsive to the market as the recovery continues. Although the steps we are taking now will maximize the value of the site over time, there will likely be an earnings implication in the second half of the year if our planning and design efforts conclude and development is still unwarranted based on market conditions. Jeffrey will provide some additional details in a moment. In conclusion, our fourth quarter and full year results, including our robust leasing volume, speak to the strength we see emerging across our markets and the Kilroy team has prepared for a busy year across every part of our platform. I want to thank the team again for their hard work and dedication in 2024 and for the energy and enthusiasm they are bringing to 2025. Eliott?

A: Thanks, Angela. The transaction market closed the year on a positive trajectory. Deal volume and financing levels were higher year-over-year with a bias towards smaller deals. In 2024, approximately 85% of office sales were under $100 million. By comparison, this number was 70% of transactions back in 2019. Another sign of progress has been the return of core capital to the sector. In the fourth quarter there were notable core deals in Austin and the Bay Area with going-in yields in the mid-6% to low-7% range. The combination of deeper bidding pools and a variety of capital sources is encouraging us to start testing the sales market again, something we put on hold over the last few years as valuations were in flux. We will focus our disposition efforts on properties where the current market value does not appropriately reflect our assessment of the medium term risk. Fortunately, our funding needs are modest over the next few years and our balance sheet is in good shape so we will only proceed with sales that meet our stringent criteria. And while we did not acquire anything during the quarter, we remain optimistic about the opportunity set of potential value creating acquisitions. Our strong balance sheet, local market knowledge and operational insights are all advantages we expect to put to good use in 2025. As always, we will remain disciplined in our approach and judicious with shareholder capital. Turning to land sales, as we mentioned last quarter, we are in advanced discussions with residential developers on two sites in our future development pipeline that are expected to generate in excess of $150 million of proceeds. There remains an acute need for more housing in Southern California and re-entitling commercial land is a logical way to address the significant and growing problem. We expect to have more to discuss on our capital recycling initiatives as the year progresses. Given continued uncertainty in the transaction market and our expectations for an elongated closing process on our land sales, guidance does not contemplate any FFO impacts from such activities and we will continue to update our expectations throughout the year. With that, I will turn the call over to Jeffrey.

Q: Thanks Eliott. FFO was $1.20 per diluted share in the fourth quarter and it was impacted by several one-time items totaling approximately $0.11 per share including a $6 million gain on the sale of the corporate plane, $4.7 million of GAAP restoration fee income and $2.5 million of GAAP termination fee income. Cash, same-property NOI growth was 70 basis points in the fourth quarter including a 90 basis point contribution related to restoration and termination fee income. Occupancy ended the year at 82.8% and it was impacted by several, large move outs that were discussed on last quarter’s call, including Capital One and Microsoft in the San Francisco Bay Area and a short term lease expiration in Los Angeles. Now let’s discuss 2025 guidance. Our 2025 FFO guidance range is $3.85 to $4.05 for diluted share representing a midpoint of $3.95. 2025 average occupancy is expected to range between 80% and 82%, a decrease of approximately 300 basis points versus our average occupancy in 2024. The decrease is primarily driven by the previously mentioned fourth quarter 2024 move outs, as well as three larger move outs or downsizes expected to occur in the first quarter of 2025, totaling approximately 216,000 square feet. Following the activity in the first quarter, no remaining expiration in 2025 is in excess of 50,000 square feet. Cash, same-property NOI is projected to decline between negative 1.5% to negative 3%. At the midpoint of the range base rent will detract approximately 50 basis points from growth, net recoveries will detract approximately 75 basis points, and non-recurring items, such as restoration fee income will detract approximately 100 basis points. Despite the almost 300 basis point decline in average occupancy expected during 2025, the limited detraction from base rent highlights the strength of our contractual rent growth across the portfolio. Please note that the same-property NOI growth is expected to be lower in the second half of the year, primarily due to the trajectory of occupancy and significant restoration fee income recognized in the second half of 2024. As part of our enhanced disclosure efforts, beginning in 2025, lease termination fee income will be excluded from both cash and GAAP NOI, a change that has been reflected in our cash same-property NOI guidance, FFO guidance assumes $3 million of such income, down from $7 million in 2024. Non-cash GAAP NOI adjustments, which include the amortization of deferred rent, and net below market rent, straight line rent and other lease related adjustments are expected to decline significantly in 2025 but remain positive with a range of $2 million to $5 million, down from over $20 million in 2024. The year-over-year decrease primarily reflects the cadence of leasing activity over the last 24 months. The combination of G&A and leasing costs totaled just under $81 million last year, a steep decline from approximately $100 million in 2023. During 2024, our focus was on both reducing the total amount of overhead spending and ensuring that each dollar of spending was appropriately allocated across the platform. As we executed on these goals, overhead spending in 2024 came in artificially low as cost savings initiatives outpaced the timing of certain platform investments. The $83 million to $85 million overhead guidance we have provided for 2025 represents a more appropriate run rate going forward. Moving to interest income, you may recall that last January we pre-funded our capital needs for 2024, resulting in elevated cash balances for most of the year which were utilized to pay down a portion of our term loan balances and repay $400 million of unsecured notes at maturity in December. We expect to maintain less cash on hand during 2025 and in turn we expect a significant reduction in interest income down from $38 million in 2024 to about $6 million in 2025. As it relates to capitalized interest during 2025, please note two things. One, as construction at KOP Phase 2 was completed in January and interest capitalization will cease at the earlier of tenant occupancy or one year from base building completion, which will now occur in January 2026. Two, as we have previously discussed, we remain committed to methodically evaluating each land parcel to determine its highest and best use and the optimal program for project execution. To provide some additional context related to Angela’s comments on the Flower Mart, we currently capitalize approximately $7 million of interest expense and an additional $1 million of real estate taxes and other expenses for the project each quarter. Our 2025 guidance incorporates a range of potential capitalization scenarios for this project and at the midpoint assumes that capitalization ceases at the beginning of the fourth quarter. This assumption, combined with our assumptions for several other parcels in the future development pipeline, are expected to result in capitalized interest of approximately $72 million in 2025 at the midpoint range versus $82.5 million recognized in 2024. We will update these assumptions as our plans solidify. In conclusion, we remain well positioned to navigate the evolving market landscape with strong liquidity, stable leasing fundamentals and a disciplined capital allocation strategy. Our continued focus on maximizing or on maintaining a flexible balance sheet, monetizing non-core assets and delivering high quality developments will allow us to drive long-term value while adapting to changes in market conditions. With that, we’re happy to take your questions.