Kilroy Realty Corporation Q2 FY2025 earnings call

• Strategic overview: Strong quarter of execution across all disciplines, with West Coast office fundamentals solidifying. Leasing: Significant strength in San Francisco and San Diego, with diverse tenant demand including AI, law firms, etc. Transaction activity: Announced dispositions of properties like 501 Santa Monica, a 4 - building campus in Silicon Valley, and land sales. Capital allocation: Active in recycling capital, pursuing reinvestment opportunities and debt repayment, and working on future development pipeline monetization. Flower Mart project: Continues redesign and reimagining, with expectation of interest and other expense capitalization at end of 2025.

During the quarter, Kilroy Realty signed over 400,000 square feet of new and renewal leases. West Coast office fundamentals continued to solidify. In leasing, San Francisco and San Diego showed strength, with San Francisco having active tenant demand near 7 million square feet. For example, a 93,000 square foot lease was signed with an AI tenant in San Francisco. In San Diego, there was broad - based activity across submarkets. Regarding financials, FFO for the quarter was $1.13 per diluted share, with cash same - property NOI growth in the second quarter being 450 basis points.

• Raised 2025 FFO outlook to a range of $4.05 to $4.15 per share, a $0.15 increase at the midpoint. Updated Flower Mart capitalization assumptions, with cessation of interest and other expense capitalization expected at end of 2025 and no assumption of capitalization in 2026. Same - property NOI growth expected to range from negative 1% to negative 2%.

• Market - related risks such as uncertainty in office market recovery, potential impact of AI - related job losses and market dynamics on portfolio performance.

Q: Congrats on the leasing and transactions this quarter. Can you talk a little bit about the type of buyers out there, the breadth of the bidding pool and whether you're seeing some owner occupants. And then just discussions on valuation, whether it's more of a price per square foot discussion or cap rates and whether it's different in San Francisco versus L.A.?

A: Eliott Trencher said every transaction is different, with buyers ranging from institutional to high net worth to owner users, and transactions had good debt, and Angela Aman added on widening types of players evaluating assets and growing conviction in West Coast office recovery.

Q: Maybe Angela, could you just provide a little bit more detail on KOP 2, the activity? I think you said 100,000 feet -- is it life science? Is it traditional office? And can you maybe just broadly talk about the economics and how those deals may stack up to your original underwriting?

A: Angela Aman said they're encouraged by activity at KOP, moving to active lease negotiations with about 100,000 feet of primarily health care and life science tenants, and it's too early to talk specifically about economics but feels good about activity stacking up to original underwriting.

Q: I guess first question is just following up on the activity you cited at KOP 2. Can you just talk about if that would be for some of the spec suites where commencement of NOI could be sooner, if it's related to that space?

A: Angela Aman said one of the transactions could be per spec suite user, and there are additional spec suite users in tour activity at the project.

Q: Just second question is going back to the campus that in the works to sell? I mean, I know you gave some metrics on it. Is there any way to maybe talk a little bit more about how you're thinking about the pricing? And you said that you thought it was a good price relative to if you had to re - lease the asset. I know there was some leasing activity going on, but any more of just sort of like a cap rate type impact, stabilized yield on cost? How to sort of think about that transaction pricing?

A: Eliott Trencher said they're somewhat bound by an NDA, but evaluate proceeds and forward - looking cash flows for potential dispositions.

Q: One of the most common questions and concerns about the market that we hear is how to think about the net impact of AI with respect to office space requirements and leasing. Clearly, the AI companies are taking space, but we've seen some additional layoffs from big tech companies that seem to be related to AI displacement. So just wanted to see if you have any thoughts on that net impact of AI?

A: Angela Aman said it's an important topic to watch, with market positioning benefiting from AI - related momentum, but also needing to be mindful for capital allocation strategy.

Q: Just my second question, just touching back on dispositions. I guess, how would you characterize the size of the portfolio that you'd consider as noncore within the KRC portfolio? And are there any specific characteristics you're looking to get away from, whether that's by market or asset quality or otherwise?

A: Angela Aman said they like markets they operate in but think about optimally positioning portfolios in core markets, with asset - by - asset underwriting to ensure return in excess of cost of capital; Eliott Trencher added looking at fundamental outlook and capital match.

Q: In the prepared remarks, you mentioned that you're kind of getting to the end of some of the larger space givebacks. Just kind of on the leasing pipeline, could you give more color on the types of tenants in the pipeline? Is it predominantly smaller to medium - sized tenants? Or are you starting to see a turn of larger tenants coming back into the market?

A: Rob Paratte said there's a wide variety of transaction sizes and types of users, with broad - based demand including different size ranges and types of users like AI, law firms, etc.; Angela Aman added on broad - based demand and growth of AI tenants.

Q: Maybe just back to Flower Mart. I was wondering if you could go through some of the types of conversations that you're having with the city. And I guess the thought is then what's the chance that they go beyond December 31. And to the extent you don't want to specifically comment on that, just kind of what's taken it from a potential of June 30 now December 31. In my kind of what's left in that potential timing that's left?

A: Angela Aman said there are encouraging conversations with the city, with additional steps in the back half of the year and expectation of updates on next quarter's call, current assumption is cessation by year - end.

Q: Rob, I know you talked in 1 of -- either the last question or the one before that about the varying sizes of leases that you're seeing in like San Francisco versus San Diego. I guess, as you think about some of the differences of San Francisco versus those other markets? And like what's driving those differences today?

A: Rob Paratte said primary driver in San Francisco is VC funding and talent base, with demand increasing in Seattle; Los Angeles is bifurcated, with winning submarkets like Central City, Beverly Hills, Culver City; San Diego has life science and defense benefits driving demand.

Q: On KOT 2, I was wondering if you could provide some color on whether or not these tenants are moving into South San Francisco or if they're just expanding or moving around within the submarket? And if you could provide any update on development yields, I think historically, we were looking at this at an 8% plus. I was wondering if that's still on the table.

A: Rob Paratte said it's a variety of tenants, some in South San Francisco, some new to market; Angela Aman said will provide better updates when deals signed.

Q: On the Matilda campus sale, can you discuss the alternatives for the campus? I know, Eliott, you mentioned that the CapEx requirement most likely. But was there a direct lease with a subtenant with that's an option for you? And how you weigh that versus selling the assets. And also if you could confirm what the cap rate was at back of [indiscernible], we get to like a low 8% cap rate, but I was wondering what your perspective was?

A: Eliott Trencher said on tight NDA, but evaluated alternatives and concluded selling for $365 million was more advantageous than leasing up.

Q: Angela, it sounds like there could be more demand at [indiscernible] coming behind the 100,000 square feet you referenced. Can you provide some color on the prospects that are in the earlier phases of -- turning on planning?

A: Angela Aman said there's a gamut of life science and health care adjacent uses, with good demand from traditional tech uses, and activity continues to shape up.

Q: You mentioned the $150 million monetization goal, which you're about halfway there. Given the state of the transaction market, do you anticipate there could be some upside to monetizing more land?

A: Angela Aman said actively evaluating highest and best uses of parcels, with potential for more monetization of land not within core competencies.

Q: On the increase in demand you're seeing in San Francisco, is there an impact of companies who had moved out of the area during the pandemic that are now coming back? Or would you say it's more homegrown demand?

A: Unknown Executive said less of companies moving back, more new company formation or expansion, with demand from companies like JPMorgan.

Q: I just wanted to go back to Caitlin's question around Flower Mart. And again, I guess I'm still struggling to understand the change in capitalization exactly what's really driving that? And then second of all, if you do end up with the local government kind of rethinking the project and you kind of get what you want, doesn't that kind of suggest you keep capitalizing in '26, because you're going to probably continue with development along those lines?

A: Angela Aman said change in capitalization due to ongoing conversations with city and need to stop capitalizing by year - end unless activities continue, and it's uncertain but committed to transparency.

Q: I have a quick follow - up on Flower Mart, and I know that was a very detailed explanation, so that was pretty helpful. But how soon do you think you could be willing to start a new development? Like you've got your new entitlement projects, would there be a scenario where you could start a new development, especially if it's a nonoffice build? Or is that something that Kilroy would be willing to do? Or would you want to bring a partner to kind of do that if it's like a different use like a resi use type thing?

A: Angela Aman said too early to answer with clarity, need to evaluate site layout, interconnectedness, etc., and will be transparent as move forward.

Q: I know in the prepared remarks that you mentioned that there is selective reinvestment opportunities that the company is pursuing after you kind of get these asset sale proceeds. I mean, should we think about this as new real estate type of investments? I mean, if that's the case, is this kind of like an acquisition and development opportunities? Or what do those selective reinvestment opportunities look like?

A: Eliott Trencher said they're all over the board, less inclined to do spec development, but looking at acquisition with value - add or core plus opportunities in known markets.

Q: Appreciate all the comments that you guys have made related to sort of the demand pipeline, turning activity and whatnot. But I guess just one quick one as it relates to sort of new leasing. Obviously, a very strong quarter in 2Q. I mean, do you guys get the sense for that sort of being a good annualized run rate of, call it, new leasing of 1 million square foot on an annualized basis? Or was it maybe 1 or 2 large leases that sort of drove that higher this quarter. Can you guys just talk about sort of expectations on the new leasing front?

A: Angela Aman said they feel good about growing pipeline and leasing momentum, hesitant to commit to specific number but encouraged by leasing shaping up.

Q: I just wanted to turn back to 2026 expirations. I think at one point, you talked about like a 200,000 square foot expiration and it was a large tenant that you thought would stay, but they could downsize. And I just want to see if you have any update on that or any of the other expirations next year?

A: Angela Aman said no specific update, but expect larger vacates or downsizes in first half of 2026, actively working with tenants but too early to say finalities.

Q: So Rob, you may have answered this in a prior response to the question, but I guess on AI specifically, given that it sounds like it's a decent amount of the pipeline, can you talk more about the exact types of buildings, locations, urban versus suburban, floor sizes, power needs, amenities and build - outs we might see for those types of tenants. Is it any different from what you see from a typical tenant end market or in the market?

A: Rob Paratte said younger AI companies look for prebuilt space for expansion, power needs like office users, typical floor size 30,000 feet in San Francisco, similar amenities to other tenants, and importance of flexibility for growth.