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This month's REIT Focus is on Kilroy Realty Corporation (KRC), a publicly traded REIT engaged in the ownership, development, acquisition and management of primarily Class A office properties on the West Coast. As of Q3 2013, KRC owned and operated 103 office properties comprising 12.5 million sq. ft. (excluding 13 properties that were held for sale). The average occupancy, revenue growth and tenants as of 9/30/13 was 92.2%, 1.8% and 654, respectively. KRC's properties are located in Los Angeles, Orange County, CA, San Diego, San Francisco Bay Area and Seattle. KRC owns a 97.8% general partner interest in its UpReit general partnership, Kilroy Realty, L.P.

KRC completed a secondary common stock offering in September 2013 for 6,175,000 shares at $50/sh. for net proceeds of $295.9 million. The proceeds will be used for general corporate purposes, acquisitions and developments and repayment of debt.

KRC was incorporated in Maryland in 1996, is traded on the NYSE, is based in Los Angeles, CA and its debt is rated Ba1 by Moody's. KRC has 82.1 million common shares outstanding and a market capitalization of approximately $4.02 billion.

Management

KRC has an experienced and solid management team that includes John Kilroy Jr., Chairman of the Board, President and CEO, who has been with the company since its formation in 1996, Jeffery C. Hawken, Executive Vice President and COO, who has been with the company since 1997 and Tyler H. Rose, Executive Vice President and CFO, who has been with the company since 1997.

Financial Data

Select financial data for KRC as of the 9/30/13 10Q and supplemental data for the period 1/1-9/30/13 is as follows (in millions where applicable):

Real Estate Assets, Gross$5,048
Total Assets$5,089
Secured, Unsecured Debt and Line of Credit$1,995
Common Stockholders' Equity2,469
Revenue$344
Net Income$11
Net Income Per Share$.13
Cash Flow from Operations$186
Unsecured Line of Credit ($500 with $0 used)$0
Market Capitalization$4,022
Property Debt to:
Gross Real Estate Assets39%
Market Capitalization49%
Enterprise Value34%
Dividend and Yield ($1.40/sh.)2.9%
Valuation Methodology:
First Nine Months Revenue Per Above Annualized (includes held for sale properties)$492
Less: Operating Expenses Annualized (excluding depreciation, amortization & interest expense, plus G&A expenses, other income and held for sale properties)187
Annualized Net Operating Income 2013$305
Projected Inflation Rate at 3.5%x103.5%
Projected Forward NOI for Next Year$316
Projected Cap Rate7%
Projected Value of Real Estate Assets$4,514
Add: Net Operating Working Capital180
Development Projects (five projects at total amount invested)861
Total Projected Asset Value$5,555
Less: Total Debt Per Above(1,995)
Series G Preferred Stock (at $25/sh. liquidation price)(100)
Series H Preferred Stock (at 25/sh. liquidation price)(100)
Projected Net Asset Value$3,360
Shares Outstanding 91.1M (82.1M common stock shares, 4.8M exchangeable note shares, 2.4M option/rsu shares and 1.8M common partnership units)
Projected NAV Per Share$37
Closing Market Price Per Share on 12/15/13$48

The gross real estate assets, property debt, revenues, net income, funds from operations and dividends per share for the years 2009 through Q3 2013 are shown in the table below:

(millions except per share amounts)2009201020112012Q3 2013
Gross Real Estate Assets$2,520$3,217$3,799$4,757$5,048
Property Debt$972$1,428$1,821$2,041$1,995
Revenues$279$302$338$405$344
Net Income$22$4$51$250$11
Funds From Operations$107$107$136$165$160
Dividends Per Share$1.63$1.40$1.40$1.40$.35(1)

(1) Per quarter

As shown above, our net asset value per share for KRC is $37 versus a market price of $48 per share. Current average cap rates for office properties (per our experience and CBRE) are in the 5% to 9% range, depending on the location, tenancy and quality of the property. We have used an average cap rate of 7% due to KRC's portfolio being primarily Class A properties in development constrained West Coast markets.

KRC's strengths include; experienced management team, low leverage of 34% of enterprise value, 100% asset growth since 2009 and stable occupancy of 92.2%. Weaknesses include; low dividend yield of 2.9%, high stock price which equates to about a 5.6% cap rate and increased reliance on construction and development projects which elevate the real estate and operating risk of the company.

We are not recommending the purchase of the stock at the current price of $48 and the low dividend yield of 2.9%, especially with the increased construction risk. KRC has more than $1 billion in development projects in the pipeline, which is about 20% of its asset base, and while the projects are well located in tight rental markets, it still adds additional development/construction risk to the company. We think there are more value oriented office REITs for investment at values below NAV and 5% yields including Mack-Cali Realty Corporation and Piedmont Office Realty Trust, Inc. KRC has doubled its assets and FFO since 2009, however, the dividend has remained the same at $1.40/sh. KRC has plenty of free cash flow and should increase the dividend.

A five year price chart of KRC is shown below:

(click to enlarge)

Source: REIT Focus: Kilroy Realty Corporation