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Kilroy Realty Corp. (NYSE:KRC)

Q4 2009 Earnings Call

January 26, 2010 2:00 pm ET

Executives

John Kilroy, Jr - President & Chief Executive Officer

Tyler Rose - Executive Vice President and Chief Financial Officer

Jeff Hawken - Chief Operating Officer

Heidi Roth - Controller

Michelle Ngo – Treasurer

Analysts

Michael Bilerman – Citi

Anar Ismailov – Gem Realty

Chris Kattan - Morgan Stanley

Michael Knott - Green Street Advisors

George Auerbach - ISI Group

Stuart Seale - Morgan Stanley

Robert Salisbury – UBS

Mitch Germain - JMP Securities

Dave Rogers - RBC Capital Markets

Presentation

Operator

Good day ladies and gentlemen and welcome to the fourth quarter 2009 Kilroy Realty Corporation Earnings Conference Call. My name is Josh and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions)

I’d now like to turn the presentation over to our host for today’s call, the Chief Financial Officer Tyler Rose, you may proceed, sir.

Tyler Rose

Good morning everyone. Thank you for joining us. With me today are John Kilroy, our CEO; Jeff Hawken, our COO; Heidi Roth, our Controller; and Michelle Ngo, our Treasurer.

At the outset, I need to say that some of the information we will be discussing this morning is forward-looking in nature. Please refer to our supplemental package for a statement regarding the forward-looking information in this call and in the supplemental. This call is being telecast live on our website and will be available for replay for the next 10 days both by phone and over the Internet. Our press release and supplemental package have been filed on a Form 8-K with the SEC and both are also available on our website.

John will start the call with an overview of the quarter and our key markets. I’ll add financial highlights and our initial earnings guidance for 2010 and then we’ll be happy to take your questions. John.

John Kilroy

Thanks, Tyler. Hello everyone and thank you for joining us today. As we reported yesterday, we ended the year with some excellent leasing results. We delivered one of the strongest quarterly leasing performances we posted as a public company executing more than 1.1 million square feet of new or renewing leases in just three months. That number exceeded our results for the first three quarters of the year combined and boosted our total executed leases for all of 2009 2 million square feet.

The fourth quarter activity was deep and broad based reaching at a pretty much every corner of our portfolio, the deals split about half and half between office and industrial and about half now between new and renewal leases. And in 53 total transactions, they include some large leases as well as a substantial number of smaller ones. Our average office leases were 14,000 square feet and our average industrial was 45,000 square feet. Overall, we converted every LOI outstanding going into the fourth quarter into an executed lease.

And more good news, the leasing pace has continued into the New Year through the first weeks of 2010, we signed leases totaling 122,000 square feet and have letters of intent place for an additional 200,000 square feet. As we’ve discussed previously, we think leasing success has to more to do with the quality of our markets and portfolio combined with our balance sheet strength in long operating philosophy than with the definitive change in overall market conditions.

Certainly the economic outlook has improved and companies are moving to capitalize on favorable terms. But historically, any sustain improvement in commercial real estate markets is preceded by job growth, which we haven’t yet seen in our markets. In addition, potential tenants are negotiating hard on new leases even in the best markets. This is evident in overall rental rate trends across the 1.1 million square feet of leases we signed in the period average rents declined 4% on a GAAP basis and 15% on a cash basis. This is in line with what we’re seeing in our markets in general.

So what we are delighted to report, we’ve outperformed the market and increased our capture rate of current demand. We’re not ready yet to forecast at a sustainable recovery has started. We believe that 2010 is likely to be a choppy period for Southern California real estate market.

Given out our number of one part company priority will continue to be our leasing of our vacant space in renewing our expirations. At the same time, we continue to position the company to take advantage of potential opportunities to expand our portfolio is difficult to predict with any certainty when or where those opportunities may occur, but at this point in the cycle, we believe attractive acquisitions over the next couple of years, our distinct possibility and we’re prepared to act under the right conditions.

We also continue to focus on enhancing the entitlement of our existing land pipeline preparing for the time we develop, well again the economically attractive. But there was a backdrop, let’s review our individual markets in our fourth quarter activity beginning on San Diego. As you all know, the region is been challenging for us over the last year, our union occupancy here was approximately 77%. The good news is that we have a significant amount of leasing success in San Diego during the fourth quarter and off to a good start in 2010.

Overall we executed lease in San Diego during the fourth quarter on 281,000 square feet of space signing or renewing leases with such names as Hitachi, Verisk, (Inaudible) and ID Analytics. We now have leases in place for almost half of the space previously occupied by our credit and home lenders along the I-15 and two thirds of the property vacated by Paul Hastings and Del Mar.

In addition in the first quarter, we signed leases with Samsung for 50% of Sorrento Gateway Lot 3 office project and a surgery center for 25% of the Sorrento Gateway Lot 1 medical office buildings. For adjusting for new leases and letter of intent, we’re now 85% committed in San Diego. The individual San Diego sub markets vacancy rates and occupancy rates are as follows starting in Del Mar. Current direct vacancy is approximately 17.5% and total vacancy is 21.6%. Our stabilized properties in Del Mar are 94% occupied and 96% leased.

South of Del Mar and Sorrento Mesa, KRC competes with two a three-story office product direct vacancy for this product type is currently 12.9% and total vacancy is 15.4%. Our stabilized properties in the sub market total approximately 2 million square feet and are currently 74% occupied and with our recent leasing success 79% leased. Further south in the UTC Governor Park sub market we compete in the same two-story product type with properties totaling 431,000 square feet for direct vacancy is about a 11.4% and total vacancy is 18.2%.

Our occupancy rate is 55%, although we have letter of intent place that would bring our company or whether our occupancy in this sub market to 88%. Along I-15 Corridor of Del Mar, Kilroy announced approximately 1.2 million square feet of stabilized office space, two-story product type here has occurred a direct vacancy rate of 12.4% and total vacancy of 13.5%.

For a Class A product direct vacancy is 36.3% and total vacancy is 37.4 although our Class A properties are 97% occupied. And total along the I-15 our stabilized properties are 67% occupied and with recent transactions 82% leased.

Now let’s move to North Orange County where we have about 3.5 million square feet of industrial space. Industrial vacancy rates here at North region is dramatically as office rates, but demand continues to be affected by the economy. The overall Orange County industrial vacancy rate was 5.8% well other properties were 8% occupied at year-end. During the fourth quarter, we made significant progress in Orange County leasing efforts signing leases for over 550,000 square feet, adjusting for new leases and letter of intent, we’re 92% committed in Orange County.

Further North, Los Angeles are overall office occupancy rate declined slightly to 88%, whereas with San Diego and Orange County, we also made leasing progress here during the fourth quarter. We sign approximately 273,000 square feet of leases and 29 separate transactions. This includes the leases with E Entertainment, Dangote, Shopzilla and Internet brands.

On the sub market perspective, El Segundo and Long Beach continued to perform well Kilroy Airport Center Long Beach are seven building office campus immediately adjacent along the airport is currently 93% occupied lease, overall has a direct vacancy here as 13.7% and total vacancy is 16.1%. In El Segundo our stabilized properties now totaled 1.3 million square feet are 97% occupied and leased.

Class A direct vacancy in El Segundo is currently 12.4% and total vacancy is 14%. Further north and west LA our properties totaled 680,000 square feet or 81% occupied and 90% leased. Overall, direct vacancy in west LA is currently 14% and total vacancy is 19%.

Finally, along the 101 Corridor market which runs through Northern Los Angeles and Southern Ventura Counties, direct vacancy in a Class A product is currently 21.6% and total vacancy is 28.4%. Our properties in the market currently are 79% occupied and 80% leased. Adjusting for new leases and letter of intent, we’re now 92% committed in Los Angeles. That’s an update on market conditions and activity.

In summary, 2009 was a very difficult year that provided mixed signals to companies thinking about making facility commitments. Notwithstanding that we’re very encouraged by our capture rate and the absolute level of leasing we achieved in the fourth quarter. It’s difficult to provide clarity on where the markets go from here.

Rents have declined, but seem to be stabilizing a current levels and increasing number of companies have began to make facility of decisions and some are even expanding, but fundamentals in our markets remain less than robust, we see 2010 is another challenging year continuing to favor high quality landlords with quality assets in quality markets. In that context are focused will be to build on our strong fourth quarter leasing momentum throughout this year and Tyler will cover the financial results. Tyler.

Tyler Rose

Thanks, John. FFO was $0.39 per share in the fourth quarter and $2.60 for the year. Included in the fourth quarter FFO is a cap gain of $0.04 of share related to the repurchase of $122 million of our convertible debt. We paid a $115 million for the $122 million face amount of debt we're on an average of about $0.94 on a dollar. Also included in our fourth quarter G&A cost is a one-time $0.17 charge related to supplement payment.

Occupancy in our stabilized portfolio was 82.8% of the end of the fourth quarter compare 82.5% at the end of the third quarter and 89.2 at the year-end 2008. By product type industrial occupancy rose to 88.2% at year-end (inaudible) 4.6% at the end of the third quarter. Office occupancy slipped to 80.6% from 81.6% at the end of third quarter.

Same store NOI in the fourth quarter was down 8.8% on a GAAP basis and 11% on cash basis have declined large reflect little over occupancy. For the full year NOI was done 9.2% on a GAAP basis and 12.1% on a cash basis. Office rents increased 22% on a GAAP basis and 7% on a cash basis for leases that commenced during the fourth quarter, while industrial rents were down 8% on GAAP basis and 18.6% on a cash basis.

For the year office rents increased 15% on a GAAP basis and 6.5% on a cash basis. Industrial rents were up 9% on a GAAP basis and down 5.4% on a cash basis. For leases signed during the fourth quarter office rents decreased 1% on a GAAP basis and 13% on a cash basis while industrial rents were 17% lower on a GAAP basis and 23% lower on a cash basis.

From a regional perspective of the rents on leases we signed in Los Angeles were up 6% on a GAAP basis and we're flat on a cash basis. Rents in Orange County were down 17% on a GAAP basis and 23% on a cash basis and in San Diego rents and leases we signed during the quarter were down 11% on a GAAP basis and 29% on a cash basis. Although it’s difficult to make estimates about market rents given our fourth quarter leasing experience, we estimate that rent levels on our overall portfolio are approximately 5% to 10% over market.

Following the significant volume of leasing we accomplish in the fourth quarter we reduced our 2010 lease expirations of 1.1 million square feet about 22% of those industrial and 78% of was officer. The office expirations include to 286,000 square foot following lease in El Segundo. As we discussed last quarter we plan to significantly modernize and upgrade this building when the lease expires at the end of July. During the fourth quarter we transferred the one remaining lease-up of property at 51,000 square foot medical office building into our stabilized portfolio. As John mentioned, this building is now 25% lease.

Turning to the balance sheet, during the fourth quarter we completed a $173 million convertible debt offering the notes mature in 2014 and have a interest rate of 4.25%. The non-cash rate is 7 and 8% for GAAP purposes. We use approximately half the proceeds to pay down our credit line and the other half to repurchase portion of our outstanding convertible debt.

We are also working on a new $71 million mortgage on the group of five office properties, the mortgage will have an interest rate of 6.51% in a seven year term. We will repay the $63 million mortgage during April with the proceeds. At the end of the year we had $97 million outstanding on our $550 million credit line, we also get noticed to our bank group that we will exercise our options to extend the credit line to April 2011.

Now let me finish for 2010 earnings guidance. Even the numerous uncertainties in today’s economy we remain causes in our near-term outlook and lets also caution that our internal forecasting and guidance reflect information and market intelligence as we know today, significant shifts in the economy and our markets going forward could have a meaningful impact on our results and was not currently reflected in our analysis.

Taking these caveats into the consideration our assumptions are as follows. Average occupancy of 84.5%, no acquisitions or dispositions, average LIBOR on our floating rate debt at 50 basis points, G&A cost of $28.5 million, which includes $0.03 a share of acquisition related evaluation expenses. Refinancing of the 72.2% $63 million mortgage at the 6.51% $71 million mortgage I mentioned earlier and the continuation of our dividend at the current level of $1.40 a share.

Taking all of these assumptions together our initial 2010 FFO guidance is $2.10 and $2.30 of share. That's the latest news from KRC. Now we'll be happy to take your questions. Operator?

Question-and- Answer Session

Operator

(Operator Instruction). Our first question comes from line of [Aaron Aslaskin] from Stifel.

Unidentified Analyst

Same questions. The first question we had was, just related to capitalizes on the interest expense, you guys haven’t had that much underdevelopment at all and I’m wondering and when do you actually plan to begin developing some of those lands that’s being capitalized and hasn’t capitalized?

John Kilroy, Jr.

Well on the capitalization front we are capitalizing our Del Mar project as we work to re-entitle that. And besides that there is only one other projects, out of it some of are finishing up on some entitlement work, we’re not capitalizing on any other piece of land

Unidentified Analyst

So the Del Mar project in the (Inaudible)?

John Kilroy, Jr.

Right

Unidentified Analyst

And you have a time line for any of that which you wanted to do?

John Kilroy, Jr.

In terms of development?

Unidentified Analyst

Yeah.

John Kilroy, Jr.

Well, the entitlement, this is John Kilroy speaking. The entitlement efforts at San Diego corporate center, property in Del Mar are going go on for another year plus that’s just the nature of the beast, and Santa Fe Summit I don’t have that in my head, but one of things we are doing at Santa Fe Summit is we have a medical group they wanted us to do a long term builder suite and we’re having a go through, a re-entitlement portion of that property.

Jeffrey Hawken

Just to clarify that on in terms of the forecasted in 2010 number, we assume we stopped capitalizing on Santa Fe Summit at the end of first quarter.

Unidentified Analyst

Okay, I was wondered about that. So stop on Santa Fe Summit at the end of first quarter.

John Kilroy, Jr.

Yes

Operator

And our next question comes from the line of Michael Bilerman, Citi.

Michael Bilerman - Citi

Thank you. Can you just go a little bit more on the 1.1 million square feet of leasing, was any of that included in the 4Q commitments of 5000, or all that is incremental?

John Kilroy, Jr.

Of the 1.1 million square feet that we leased in the fourth quarter about 20 super center, 26,000 square feet commenced in the fourth quarter

Jeffrey Hawken

So the remaining is all further out.

Jeffrey Hawken

Remainder is in 2010, about 375,000 in the first quarter and about 100,000 in the second quarter and about 400,000 in the third quarter.

Michael Bilerman – Citi

That’s in terms of when they commence

Jeffrey Hawken

Correct.

Michael Bilerman – Citi

And then how much of that you talked it being new in renewal. The renewal leasing was that 2010 expires or were those further out in terms of expirations that you renewed early?

Jeffrey Hawken

The renewals that we did in the fourth quarter were a mix of that, I mean there was some renewals in the fourth quarter and some renewals in 2010, the bulk of it was 2010 renewals.

Michael Bilerman – Citi

So most of this 1.1 million square feet either represented vacant space or 2010 expires, there was nothing sort of further out in 11, 12 or 13 that you pushed out?

Jeffrey Hawken

No.

Michael Bilerman – Citi

Okay. And then when you talked about the leasing, the spreads down 4%, down 15 on a cash basis, that was in relation to the 1.1 million in total?

Jeffrey Hawken

Correct.

Michael Bilerman – Citi

Okay. The second question was just to go a little bit on G&A, can you talk a little bit about I guess what drove the higher than expected G&A than you are expecting in the fourth quarter, is it effectively tied to the excess leasing that you did that goes back to the 2009 bonus plan?

Jeffrey Hawken

Yes, the 2009 bonus plan has various metrics associated with the one which was leasing and when we forecasted our numbers at the end of the third quarter, we didn’t anticipate the level of leasing that we would achieve and what happened was based on those metrics the incentive compensation across the company was up about $2.4 million or so related to the increase in leasing during the fourth quarter. So the overall incentive compensation is down about 63% from last, but versus our third quarter forecast is up about $2.5 million or so.

Michael Bilerman – Citi

When you are saying incentive comp is down 63, we were to breakout the cash and the stock comp in 2009 versus 2008 and recognize some of the stock comp is previous year comp plans that also probably have stock price grant that were much higher and so you are accruing stock expense at a much higher rate, but let’s put that aside, but if were to just look at ’08 versus ’09 and we strip out (Inaudible) severance charge, your cash comp is about $21 million versus $22 million last year and the stock comp was about $12 million versus $15 million last year. So a total G&A of about 33 versus 37, so I’m just trying to breakout your 60% numbers is in relation to what?

Unidentified Participant

The total awards that were granted in 2008 not was expensed, but in terms of the awards that were granted that some were expensed in ’08 some were amortized over the next three years versus what was granted in ’09 again some were expensed in ’09 and some were amortized in the future. But the total awards was down 63%.

Michael Bilerman – Citi

That was when we looked back to the original 2009, 8-K from early ’09 it talked about the awards being set about 60%, so if you are saying it was down 63% does that effectively mean that every one hit the Max award.

Unidentified Participant

No, no one hit the Max award.

Michael Bilerman – Citi

Can you break out, you talked about $28.5 million for ’10, can you break that out between stock and cash and how much of that includes deferral from last year?

Unidentified Participant

Well, in the 28.5 the share based comp from prior years is about $4.5 million in that number. As I mentioned we have $1.5 million of acquisition cost that we haven’t had previously. So I don’t think, that answers your questions, but it is about $4.5 million of service comp from prior year plan on that number.

Michael Bilerman – Citi

Total of how much, I guess it was $12 million in ’09, you know 4.5 from prior years.

Unidentified Participant

I’m not sure what you are getting at $12 million from (Inaudible). In the ’09 number prior year costs were about $9 million or so. Prior year plans I think that was included what –

Michael Bilerman – Citi

Prior year plans; I just think the total, the total stock comp in the 2008

Unidentified Participant

Prior year plus ’09 is about $12 million, in 2010 prior year, plus what we estimate for 2010 plan is about $6 million. It sounds about $6 million, which we said consistently over the last several quarters.

Operator

And our next question comes from line of Anar Ismailov from Gem Realtors.

Anar Ismailov – Gem Realty

Hi, this is Anar from Gem Realty, couple of quick questions. The $5 million termination fee, which tenant is it associated with?

Unidentified Participant

Are you talking about the fee from last year in ’08.

Anar Ismailov – Gem Realty

I heard there was a $5 million termination fee, Oh it is last year, okay, never mind (Inaudible). And then the other question is, what’s the status of the (Inaudible) in Long Beach?

Jeffrey Hawken

This is Jeff, the lease of (Inaudible) is scheduled to expired later this year at September 30th, and that’s current status as we speak.

Anar Ismailov – Gem Realty

Do you know their intentions to renew (Inaudible).

Jeffrey Hawken

Yes, their intention is to go to a different site down size about half of that current space and so that’s the plan (Inaudible) right now.

Anar Ismailov – Gem Realty

Got it. And last question what is the status of the Intuit at your Governor Park property?

Jeffrey Hawken

We have a letter of intent on that building for the entire the year. Sorry, as a former, I was speaking of the former Intuit building under 41,000 square feet, the 75,000 square feet they were in…

Unidentified Participant

They extended that for couple of years.

Unidentified Participant

What just was, we extended that for couple of years.

Operator

And our next question comes from line of Chris Kattan from Morgan Stanley.

Chris Kattan - Morgan Stanley

My question is around the occupancy guidance you gave, 84.5%, what is it 83% now 82.5 and what’s driving the increase here, is that based on leases you’ve already signed or incremental new leases you think you may sign. Can you provide some additional commentary around that?

Unidentified Participant

Yeah, it’s a combination of all that. We have to do more leasing obviously in 2010, we just did a bunch of leasing in 2009 that’s going to come into play, but we also have expirations in 2020 that we’ll need to deal with and we are not going to renew all those so combined all that together and we are estimating average occupancy of 84.5. As I mentioned earlier, some of the fourth quarter leasing doesn’t come until the third quarter of 2010, so from an average perspective we won't hit the numbers until the third quarter.

Chris Kattan - Morgan Stanley

Yeah, that’s helpful. I guess the follow-up question is that it sounds like there is some leases to recommence, it had some write downs in Array. How do characterize the negotiations with growing tenants, but they are just really pushing for RAID, is that move out of real tenable situation or that type of comment?

Jeffrey Hawken

This is Jeff. Obviously the tenants have been negotiating very hard on all leases for renewing our new space. They are very focused on the bottom line, you are looking, as they compare renewing versus (Inaudible), what the cost that would be? Again, we are very well positioned with our assets location, so we have a leg up, I think on a lot of our competition where tenants on a stay, but they are focused very much on the bottom line.

John Kilroy, Jr.

The other thing they are very focused on is that is quite a moment by tenants in their tenant rep brokers right now to take advantage of favorable economics try to lock in more favorable economics for a longer term. There is a moment towards quality, there is certainly a moment, what we are seeing very strongly is a moment towards certainty so rather looking at value all around they are also look at certainty of their land lord and that sort of thing and that’s what’s driving decisions right now.

Operator

And our next question comes from line of Michael Knott of Green Street Advisors. Michael, you may proceed. Michael, your line is open, you may proceed.

Unidentified Analyst

Okay, this is an [Enrique Torres] on behalf of Michael. Question about, during the call last time you mentioned that San Diego had seen a bottom, but LA was still struggling. If I look at the signed leases, it seems rental rolling down more than on the signed leases versus the commence, so can you give a little more color on what you are seeing in the San Diego and LA markets and if rents have bottomed there and they are kind of bouncing back a little or do they still have some more room to fall?

Jeffrey Hawken

Yeah, this is Jeff. I think as we’ve talked earlier in this call, the rent decline was less in the first three quarters and we’re seeing a little bit more in the fourth quarter, and I would characterize it as, there is still downward pressure in certain markets, certain buildings, but I think we’ve sort of seen hopefully here the bottom of that. As I said earlier, there is a lot of pressure negotiates leases, our tenants are pushing very hard to get the best deal they can, but it seems like we’re probably at the low rent that range.

Unidentified Analyst

Now, are you seeing San Diego having more momentum right now than LA in terms of activity?

John Kilroy, Jr.

That’s the tough one I think. This is John speaking, the tough one to answer, but what we have seen for Kilroy is that the level of activity in San Diego has picked up dramatically from a year ago that’s reflected both in the leasing results we’ve had here particularly in the fourth quarter and early in this 2010, as well as in the transactions that we have under negotiations. So we seen a significant increase and people willing to make decisions in San Diego we seen the significant increase in folks wanting to take advantage of the market, but by no means are we in a robust market in any of the sub markets in which we operate.

Unidentified Analyst

Okay, and then just one quick follow-up. If I look at the property list what’s in the supplemental that you would see like 16 properties that are currently vacant in San Diego out of your portfolio, can you give me an idea of what this looks like Pro forma for all the leasing activity that has not yet commenced, so how many of assets of ones that are currently vacant are you seeing activity or that are leases were signed at those properties?

Unidentified Participant

(Inaudible) talk about the occupancy at 77% in San Diego based on leasing we’ve done, that number has moved up 80, 85%.

John Kilroy, Jr.

Yes, in terms of the number of buildings I have to go back and count them up, but we can do that offline at some point for you, but...

Unidentified Analyst

Which was like (Inaudible) where you’re seeing a lot of activity in the empty buildings or are you just kind of also just filling more occupancy, more assets that are currently occupied?

John Kilroy, Jr.

We’re seeing. This is John. We’re seeing both. We’ve been able to renew folks; we’ve been able to lease existing vacant space and the demand that we’re seeing right now is principally for buildings that are currently vacant.

Operator

And our next question comes from the line of George Auerbach from ISI Group.

George Auerbach - ISI Group

Of the leases signed in the fourth quarter, which didn’t yet commence, what percentage were office leases?

John Kilroy, Jr.

That did not yet commence?

George Auerbach - ISI Group

Yes.

John Kilroy, Jr.

Well, of all those leases that commenced, of all the 1.1 million square feet only 39,000 square feet of that was office leases that commenced in the fourth quarter.

George Auerbach - ISI Group

Okay. And you quoted rent roll down to 13% on those office leases that are signed, but didn’t commence. Can you give us an idea where net rents are on those leases and also what the capital costs were on a per square foot per year basis?

John Kilroy, Jr.

Well, on a capital cost question I haven’t calculated the per year analysis, but the average office TI for the leasing we did in the fourth quarter was about an average of $27 a foot that breaks out between renewal and release in the various counties, but it’s about $27 a foot on average for both renewal and release. And your first question once again?

George Auerbach - ISI Group

Just trying to quantify the net rents in LA and San Diego on these new leases?

John Kilroy, Jr.

Well, I mean it ranges all over the place, because you got some triple net buildings, you got some full-service gross buildings and you got two story and four story, I’m not sure we really have an average rent number that we are prepared to give out.

George Auerbach - ISI Group

Okay. And John you mentioned some just over on weakness, but what’s your outlook for the direction of net effective rents in 2010 in office?

John Kilroy, Jr.

Well, as Jeff said, we think our portfolio right now is somewhere between 5% and 10% over market in terms of what the rents we’re seeing right now. We also feel that rents have began to stabilize, but have to say that every time we look at the Wall Street Journal or turn our computer and see what’s coming out of Washington or what’s coming out of the rest of the world. It changes the views of decision makers and that has after the direct impact or at least a significant impact on what demand is and therefore what rentals are going to be and so forth.

So I don’t mean to be a queue it’s just that the crystal ball is not nearly as clear as it would be later in the cycle and I think this is one of those periods where you just you’ve got to meet the market, we tried to do better than the market. The rents we’re seeing right now, we think we certainly hope are near the bottom, but I’ve learned a long time ago that if I had absolute certainly with regard to that, I will be in a different business.

George Auerbach - ISI Group

Right. And finally on the 325,000 square feet of leases signed in LOIs in the first quarter, how much of that activity is net new absorption to your portfolio compared to renewal and also could you give us an idea of what the breakout is office verse industrial?

John Kilroy, Jr.

Well, on the leases signed its pretty much all office. And in terms of new and renewal on that base it’s about 30% renewal and 70% office or so. And then on the LOIs, it’s predominantly office and most of it is new space versus renewal, meaning currently vacant space.

Jeffrey Hawken

Correct.

Operator

(Operator Instructions) And our next question comes from the line of Robert Salisbury - UBS.

Robert Salisbury – UBS

Hey, guys how are you doing. I was wondering with the total current pipeline were signed LOIs on square footage?

John Kilroy, Jr.

LOI right now is about 200,000 square feet.

Robert Salisbury – UBS

Okay. And also you guys talked about [Dubai] lease and you were not sure what’s going on there yet, but I was wondering if you guys did have the visibility on the other big plan move-ins or move outs over the next several quarters?

John Kilroy, Jr.

Well, in terms of LOI expirations we have 1.1 million expiring in 2010, 400,000 of that is Boeing in end of rise so that’s brings it down to 700,000. But we don’t have anything over 100,000 square feet in that category. So there is really nothing significant in that bucket for lot of smaller deals.

Operator

Our next question comes from the line Mitch Germain from JMP Securities.

Mitch Germain - JMP Securities

Just some background details on the types of customers that are in the market right now for space?

John Kilroy, Jr.

Jeff, you want to go.

Jeffrey Hawken

It's pretty broad brush across the portfolio, it’s financial, it’s entertainment software some defense, I mean it’s pretty diverse.

Operator

And our next question comes from the line of Dave Rogers from RBC Capital Markets.

Unidentified Analyst

Hi this is [Mike Joel] with Dave. Where is your demand coming from, are there new tenants in the market, or they are existing tenants just moving around from a different space?

John Kilroy, Jr.

Its combination of both, about 60% of the tenants that we’re seeing are folks that are talking advantage of the market that they might be slightly up sizing or getting more efficient and efficiency is the word you hear frequently and ever increasingly. So about how do they get more efficient, how do they make sure they have the facilities that work for them.

As you know the energy is becoming increasingly a concern to people. Green buildings are becoming increasingly a concern. So all these things that are into 40% of what we’ve seen at least the fourth quarter. People are actually growing, better increasing because their business is doing better. So that’s kind of the breakdown. Whether that holds from quarter-to-quarter, I think it will probably bounce around, but that’s sort of what we’re seeing now.

Unidentified Analyst

Are you seeing any new tenants moving into your markets?

John Kilroy, Jr.

Well, yes. We’ve got a couple of tenants that moved down to San Diego, but I characterized most of it is tenants that are in the market. Some of them roughly 40% are expanding and 60% of whom are wanting to get more efficient and are move up into a higher quality building that they can afford in this market.

Operator

And our next question comes from line of Michael Bilerman from Citi.

Michael Bilerman - Citi

John, I suppose I come back to acquisitions in the market place and I was wondering if you can spend some time talking about hiring of Chris and what that sort means for the Kilroy franchise and what he brings to the table and what sort of things you're looking at today?

John Kilroy, Jr.

Well, that's an area that we're very focused on, I don’t share the enthusiasm that lot of folks have for current steels in the marketplace. There are some there is not a huge magnitude of extraordinary deals like we saw back in the early 90s in the marketplace whether that will change remain to be seen, but as you know there's a lot of capital on the markets. Some of the things we're seeing right now have been bid up, there is a property here in the west side we think it is going to trade at ridiculous price given the quality and the market it’s in so far.

On the other hand in hiring Chris, we do see that there are opportunities over the next couple of years some of those are not just buildings, but they are entity at the entity level and we're having a number of discussions right now very early stage with folks who know they are going to have a difficult time competing with companies like Kilroy or Douglas, Emmett or whatever and some of those companies are in LA, some are in other markets, but they recognized that they've got equity, they have some development opportunities as well, but they don’t have a capital structure that allows them really to compete. So those kinds of discussions are exciting to us because what we're hope is we’ll uncork couple of [Alan] company type transactions and you know that workout well for us down in San Diego.

On the specific asset situation we're looking at everything obviously and Chris brings them a broad back ground and working in the acquisition area and what not of previously with a fun, but he has great relationships we're not looking at doing a fund, but we are talking with a number of folks that are pension investors and what not that are looking at recalibrating their portfolio and selling assets and what not.

So Chris brings with him a level of relationships and contacts that increases the breadth of what we had before. We’re taking in the acquisition side very seriously as you know, Michael, in the past trophy part of this cycle too I was not an acquired, I think we quit basically in early 98 doing any sizable transactions except for those periodically that had real value added play we were not bubble buyers we're not going to be bubble buyers, but we feel that we need to have a real dedicated efforts towards the acquisition area and that's where we're heading.

Michael Bilerman - Citi

You mentioned in your opening comments something about the right conditions that would be too exist to buy, given the fact that there is going to be a lot of vacancy in the market place, how do you go about pricing that vacancy and what sort of conditions need to exist for you to act?

John Kilroy, Jr.

Well, it’s going to depend obviously on the product in the specific market, so we got pretty long discussion about the hypothetical there, but one thing the Kilroy is not going to do is buy assets that we feel uncomfortable with from a qualitative standpoint. We think that’s a game its very dangerous, will let others play that. We like our quality markets it’s not that we don’t like vanilla buildings, we do, but they got to have various operating characteristics.

One thing the Kilroy has of course is that vertical capabilities of developing in value added and so forth. So when we underwrite these things, we think we have a pretty good view as to what the real costs are to reposition buildings, we’re very sober about that. So we have a lot of assets that we’ve been tracking that we think are going to be interesting place where there are value added opportunities and by that only huge development, but where they require some corrective measures to make them the current buildings that will stand a tested time and we think we’re well suited to that.

So right now we’re looking at a lot of things, we haven’t made a specific move on anything, we’re having a lot of discussions up and down the coast and we’re confident overtime that those will lead to some successful acquisitions. We’re not going to stray into the crazy markets, we’re not going to buy assets that are the sea level and so forth. And we can find B asset move it to an A minus and it’s in the good market that sounds interesting.

Michael Bilerman - Citi

And then when you are saying up the coast, I assume you just saying potentially up the Northern California or you venturing up?

John Kilroy, Jr.

So we’re going to look as we said back in (Inaudible) everybody don’t be surprised if you see Kilroy looking a large different markets up and down of west coast. We think we have to understand what’s going on, but that doesn’t mean that we are necessarily play in those markets. But we’re having a lot of discussions and reviewing a lot of different markets right now from one border to the next. But don’t get excited when I say that, because it doesn’t mean we have some big plan to go by Portland or something we don’t.

Michael Bilerman - Citi

Right. Next question for Tyler, if we look at guidance 210 to 230, and if you take a look at fourth quarter, if it is $0.39 in FFO if you add back the $0.11 from the net gain versus the severance charge on the comp charge on debt, you get about $0.50 and that’s including about a $10.9 million G&A number versus $7.25 million respectively in the quarterly guidance for next year, so about another $0.08 that sort of gets you to 58 on a sorter run rate with an average occupancy in the fourth quarter of about 83% versus an average occupancy for 2010 of 85. If you take the 58 and multiple by four you get 232. I’m just wondering what sort to get a $0.20 below that had a sort of current run rate, when occupancy is going up and I expect that there some rent low down as we had into next year, but I would assume 140 basis points of occupancy take up an average basis would more than to get that.

John Kilroy, Jr.

Yeah, well I need to go through my model with you in detail, if you like, but the interest cost were up, we obviously have roll down and ran and the numbers were coming up with in terms of lease up and we have expirations coming, we have bowing moving out and so with, we’re comfortable with our guidance given that, I have to check in the method is went through and go through that in detail.

Michael Bilerman - Citi

Is the 84.5 you’re saying that’s an average 2010 were that’s an ending 2010 average?

John Kilroy, Jr.

Average. As I mentioned earlier to somebody else there has lot of the leasing we did in the fourth quarter doesn’t start into the third quarter of 2010, so that you will be lower than that in first quarter obviously.

Michael Bilerman - Citi

And where would it end the year than based on all the leasing attraction that you have?

John Kilroy, Jr.

Well, if assuming everything goes as where we plan closely 86% .

Michael Bilerman - Citi

86% okay. And I just want to make I have the numbers down correctly for the $28.5 million G&A, you are saying the stock comp portion is about $10.5 million and priors to 4.5 from previous plans than $6 million from current.

John Kilroy, Jr.

No, no the stock comp is about $6.6 million

Michael Bilerman - Citi

Six total and 4.5 of that is previous

John Kilroy, Jr.

Yes

Michael Bilerman - Citi

Okay, and then are you going to be releasing the actual targets that much as the metrics, but the actual target as part of the 2010 bonus plans so that the street can be very well aware in terms of what your board is to earn there was bonus payment.

John Kilroy, Jr.

We’ve never disclose the detail budget numbers and we don’t plan to do that.

Michael Bilerman - Citi

Okay, well I would at least one man's opinion is perhaps providing that disclosure so that at these people know where those hurdles are relative to payment so that they are surprise, when the company reports a higher G&A number they didn’t know why, my opinion is feel free to ask others as well.

Operator

Our next question comes the line of Stuart Seale from Morgan Stanley.

Stuart Seale - Morgan Stanley

Thank you, first of all Tyler I’m delighted to see that you too are competitive in consider land speed record with your prepared remarks.

Tyler Rose

Most of it has been a long time.

Stuart Seale - Morgan Stanley

It has indeed. On the comment about the market rents been I think you’ve said roughly 5% to 10% in place being 5% to 10% over the market. Is that on a GAAP basis or cash basis?

Tyler Rose

Cash.

Stuart Seale - Morgan Stanley

I am sorry can you repeat it please.

Tyler Rose

Cash

Stuart Seale - Morgan Stanley

Cash. And I guess it is a little bit of follow up on the Michael’s question, if you look at the 84.5% average occupancy forecast for 2010, that’s little up from where it was at the year end, but it’s a little – about 50 basis points lower than what the average was for the same-store pool in 2009. What is your average occupancy translated to in terms of just an overall internal grow same-store NOI cash basis for 2010?

Tyler Rose

Well, our projected same-store numbers for the year for 2010 are down 7% on a cash basis and down 2% on a GAAP basis.

Stuart Seale - Morgan Stanley

Okay, does that include any forecast for and I apologies I just (Inaudible) does that exclude the impact lease termination fees?

Tyler Rose

Yes.

Stuart Seale - Morgan Stanley

And are you forecasting any lease termination for 2010 at this point?

Tyler Rose

No.

Operator

And our next question comes the line of Erin Veloskin [ph] from Stifel.

Unidentified Analyst

Hi, thank you for taking my question. When I ask about the cash gain on debt extinguishments, how just the..

John Kilroy, Jr.

Can you speak up, because we can’t hear you.

Unidentified Analyst

The cash gain on early debt extinguishments of $5.1 million, why is that so difference sense the 1 million or 1.3 million that should reported on your income statement.

Jeffrey Hawken

What we do from our reporting prospective is the under the account rules we adjust FFO differently in the forecasting that we achieve. So, when we brought back $122 million of convertible at 100 to $117 million that was the $5 million effectively cash gain from FFO reporting GAAP purposes for only accounting 1.8 million of that.

Unidentified Analyst

Okay. All right, I just think most your peers count that as a non-cash, that was asking. Okay, and then also the CapEx on the base building CapEx, in to pick up pretty significantly this quarter, what was the thinking region behind that.

John Kilroy, Jr.

I don’t think is going to any particular, I mean have you saw in building maintenance cost?

Unidentified Analyst

Yeah. That was pop to $5 million in the quarter from maybe $2 million from previous quarter.

John Kilroy, Jr.

Yeah. When a couple projects that came through in that quarter down one down in San Diego and one in West LA that we’re little higher than the average.

Unidentified Company Speaker

So this is something unusual, just the timing difference with different projects.

Operator

And at this we are showing no further questions available. Tyler Rose you may proceed.

Tyler Rose

Thank you for joining us today. We appreciated your interested in KRC. Good bye.

Operator

Thank you for your participation in today’s conference. This concludes the presentation and you may now disconnect. Have a great day.

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Source: Kilroy Realty Corp. Q4 2009 Earnings Call Transcript
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