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Executives

Tyler Rose - CFO

John Kilroy - CEO

Jeff Hawken - COO

Chris Corpuz - EVP, Acquisitions & Strategic Initiatives

Heidi Roth - Controller

Michelle Ngo - Treasurer

Analysts

John Guinee - Stifel

Dave Rodgers - RBC Capital Markets

James Sullivan - Cowen and Company

Steve Sakwa - ISI Group

Josh Attie - Citi

Mitch Germain - JMP Securities

Michael Knott - Green Street Advisors

Chris Caton - Morgan Stanley

Anthony Paolone - JPMorgan

Dave Aubuchon - Robert W. Baird & Company

Kilroy Realty Corporation (KRC) Q3 2010 Earnings Call October 26, 2010 12:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the q3 2010 Kilroy Realty Corp. earnings conference call. (Operator Instructions)

I would now like to hand the call over to your host for today, Mr. Tyler Rose, CFO.

Tyler Rose

Good morning, everyone. Thank you for joining us. With me today are John Kilroy, our CEO; Jeff Hawken, our COO; Chris Corpuz, our Head of Acquisitions; 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 in a bit of a change from prior quarters will provide general commentary on our various markets rather than specific market statistics. We've added a page to our supplemental that includes the detailed market data. I'll follow John with financial highlights and updated 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. We had another fast-paced and successful quarter at KRC. We're excited to report continued leasing success as well as announced that we are under contract on two new acquisitions. Let me start with a brief review of our market conditions.

Overall, we believe we have seen the bottom in most of our markets, although the recovery is relatively muted by historical standards. Having said that, San Diego has now experienced positive absorption for three quarters in a row and we are now 82% occupied and 87% leased there.

The Orange County industrial market had slightly negatively absorption in the third quarter, but we have moved our occupancy to 90% and over 94% leased in that market. The Orange County office market had positive absorption for the first time since 2007.

In Los Angeles and Ventura Counties, we're seeing modest activity. Absorption was slight negative in the third quarter, but our occupancy is holding at 90%. That's down from 93% at the end of the second quarter, driven partially by taking our 300,000-square-foot 2260 building previously occupied by Boeing in El Segundo out of service for planned redevelopment that commenced in August.

And finally, in the South Financial District of San Francisco where our 303 Second Street building is located and where one of our just announced acquisition is also located, demand is growing with total vacancy rate of 12.6%, a full 5 points below that of the overall market. Jones Lang LaSalle has reported a quarter-over-quarter rate increases of 7% in this submarket, driven by significant demand from the tech sector. In addition, one of San Francisco's premium real estate brokerage firms, CAC, is reporting that 2010 will be the biggest year yet in terms of leasing with tech-related companies.

At KRC, we're benefitting from these modest improvements in market conditions as well as a tenant credit quality and an increased preference by tenants to do business with well-capitalized landlords. We maintained strong leasing traction during the quarter and signed almost 462,000 square feet of leases. Year-to-date, we've now signed leases on more than 1.3 million square feet, about 80% of leased transactions in the third quarter for office space. Over 50% were in the San Diego submarkets and about two-thirds of the transactions were on Vegas space.

Strong leasing continues to boost our occupancy levels. At the end of the third quarter, occupancy in our stabilized portfolio was 86.4%, up from 85.1% at the end of the second quarter and up 360 basis points from 82.8% at yearend 2009. Our stabilized portfolio was 89% leased at the end of the quarter.

Since the end of the third quarter, we've signed additional leases totaling 227,000 square feet, including a large industrial lease in our Orange County industrial portfolio. In addition, we now have approximately 550,000 square feet of unplaced letters of intent of which about half are for new leases and half are for office space in San Diego.

Based upon the level of interest that we're seeing to date throughout most of our portfolio, particularly in San Diego and Orange County, we anticipate that we will continue to make occupancy gains.

Turning to our growth initiatives, our investment strategy is simple and straightforward. We aim to take advantage of certain inflection points as the real estate cycle progresses. In the early stages where we're right now, our strategy is to buy high-quality, irreplaceable core assets in top tier markets at discounts to replacement cost. We seek well-leased properties with sufficient term to get us to a better point in the cycle. This should generate good stabilized yields with the ability to grow them over time.

As the recovery begins to gain steam and job growth occurs, we will move further out on the risk curve to purchase more value-added acquisitions with more lease-up opportunity.

Finally, when we reach a strong recovery that includes significant tenant demand, lower vacancies and higher rent growth, we anticipate that we will once again focus more of our investment attention on development where historically at that point in the cycle we have achieved superior risk-adjusted returns.

Over the last 13 years, we've invested roughly equal amounts of capital in development and acquisitions. In the real estate bubble markets of 2005 through 2007, we invested nearly $450 million in development starts at yield of 300 to 500 basis points higher than acquisition cap rates at the same time. This year given, where we are on the cycle, we are focusing more on acquisitions year-to-date, and assuming we close on our two pending transactions. We will have invested nearly $667 million in acquisitions purchasing, high quality assets in terrific locations and meaningful discounts to replacement cost.

Our buying criteria is disciplined in fair cut, we stick to what we know, for pursuing opportunities in key West Coast's locations, where we have deep market knowledge and experience. We buy properties at prices below replacement cost, and include significant amenities, and great access to transportation and infrastructure. We look for properties where we can increase rents, as well as those that are well leased to provide current cash flow.

Finally, in all of our acquisition efforts, our primary objective is to purchase properties that will appreciate over time to build significant shareholder value. Our two pending acquisitions reflect these priorities. We are currently in escrow to purchase 100 First Plaza, a 466,000 square foot, 27 storey office property, located at the corner of First and Mission Street, in the South Financial District of San Francisco. The purchase price is approximately $191 million or $410 per square foot.

This is a strategic opportunity to buy a property that will be a direct beneficiary of San Francisco's $1.7 billion TransBay Terminal Project, where work is already begun. This publicly funded multimodal infrastructure project will include new terminals to accommodate multiple types of transportation, a 5.4 acre park, and new housing, retail and commercial properties; 100 First Plaza is directly adjacent to these improvements.

The new terminal has been dubbed to Grand Central Station of the West. These transformational improvements will further enhance the areas attractiveness, and the value of our projects at 303 Second Street and 100 First Plaza.

As many of you know, the area to the South of market, which includes the South Financial District has experienced a major revitalization over the last several years. And now with the addition of the TransBay Terminal, it's only improved its position as a preferred location for media and tech tenants, including those in the search, social and mobile media, cloud computing and similar industries.

As I mentioned earlier, this market is outperforming San Francisco's traditional CBD, and has captured the bulk of recent leasing in the overall market. For example, we have moved our lease percentage to 303 Second Street from 89% to 96%, since we acquired the project just five years ago. 100 First Plaza is a LEED Gold certified building and is currently 76% occupied and 94% leased to top credit tenants.

The average lease term extends for another six years, so the building represents both, strong current cash flow and excellent appreciation potential. The initial return at 76% occupancy is approximately 5%, upon stabilization of current leasing at 94% occupancy the yield will be approximately 7%.

This acquisition is a perfect example of an opportunity that was not formally marketed, but one that we pursued, given our view that the asset will be substantially enhance in value by the TransBay Terminal improvements. Upon completing our acquisition of 100 First Plaza, we will have roughly 1.2 million square feet in the South Financial District, with 95% of the total space leased.

In a separate transaction, we're also in escrow to purchase Overlake Office Center, a 122,000 square foot, three-storey office property located in Bellevue area of Greater Seattle for approximately $46 million or $377 per foot. The building is directly across the street from Microsoft's main corporate campus, and is 100% leased to Microsoft through December 2014.

This is an opportunistic buy in an off market transaction of a terrific asset, the prices below replacement cost, and well below recent sales in the area. Building rents are below market, and a $30 million overpass that connects property to Microsoft's campus, is expected to open by year end. Initial yield is projected to be approximately 6.4%.

Just as we had a previous track record in the Bay area, KRC has had a 30 year plus track record in the Greater Seattle area. We sold our last asset in 2007, as a cyclical peak in real estate values. We have a strong understanding of the dynamics of this market, and we believe in its continued growth, especially in affluent and tech-heavy locations like Bellevue Redmond corridor.

In summary, we continue to make significant leasing progress, and expect to make further occupancy gains, given the demand we were seeing in most of our markets. In Santiago, we believe we have turned the corner. From a growth perspective, we believe we are in initial stages of recovery, when acquiring quality, well these properties that had strong value drivers make sense. Our pending acquisitions are well leased with strong cash flow, and provide the opportunity to significantly increased value over the long term.

100 First Plaza further solidifies our San Francisco presence and expands KRCs platform, and what has become San Francisco's strongest sub-market. That's an update on the quarter. Now Tyler will cover our financial results.

Tyler Rose

FFO was $0.54 per share in the third quarter and/or $0.51 from the first nine months of the year. We ended the third quarter with occupancy in our stabilized portfolio to 86.4% up from 85.1% at the end of the second quarter. By product type, office occupancy was 84.8% and industrial occupancy was 90.6%. Overall, our properties are around 90% leased.

Our third quarter same-store NOI increased 2.9% on a GAAP basis, just under 1% on a cash basis. For the first nine months of the year, same-store NOI declined 3.1% on a GAAP basis and 4.8% on a cash basis. The leases that commenced in the third quarter, office rents were up 19.5% on a GAAP basis and 5.2% on a cash basis. Industrial rents decreased 22.3% on a GAAP basis and 30.9% on a cash basis.

The leases that commenced in the first nine months of the year, office rents declined 14.1% on GAAP basis and 11.3% on a cash basis. Industrial rents were down 22% on a GAAP basis and 28.3% on a cash basis.

As John mentioned, we signed new and renewing leases during the third quarter on 462,000 square feet of space. Office rents on these leases decreased 6.4% on GAAP basis and 8.7% on a cash basis. Industrial leases decreased 2.9% on a GAAP basis and 15.3% on a cash basis. Further in October, we have signed 227,000 square feet of leases most of which are in Orange County.

Finally, for the 450,000 of letters of intent, office rents would increase 1.7% on a GAAP basis and be down 5.6% on a cash basis. Industrial rents would decrease 20.6% on a GAAP basis and 27.4% on a cash basis. Rent levels remain relatively flat and we continue to estimate that rents in our overall portfolio approximately 10% over market.

We have manageable lease expirations in 2011 as approximately 8% of our portfolio rolls over next year, that compares to about 16% this year. In terms of funding the acquisitions, we currently have approximately $275 million of capacity in our bank line and we can expand it another $200 million through and according feature. Given our low leverage, we plan to take advantage of the low interest rate environment and currently evaluating the issuance of both unsecured and secured debt.

(inaudible 6-2:21) acquisitions expected to close later this week and the San Francisco acquisition is expected to close in early November depending on due diligent items.

In addition, we do anticipate increasing our disposition program in order to fund our growth initiatives. As you know, we've utilized this capital recycling strategy since our IPO. As in the past, we'll provide 2011 guidance including projected dispositions on our fourth quarter call.

Finally, we will post on our website more property specific information on the acquisitions (inaudible 6-2:52) closing. And we're also working on setting up an investor day in San Francisco, more to come on that.

Now let me finish with updated 2010 earnings guidance. Given today's economy, we remain cautious in our near terms outlook and our ability to accurately forecast. Our internal forecasting guidance reflects information and market intelligence as we know it today. Significant shifts in the economy and our market going forward has a meaningful impact on results in ways not currently reflected in our analysis.

Taking these caveats into consideration, our assumptions are as follows: last quarter we provided guidance of $1.97 to $2.07 a share and year end occupancy guidance of 87%. Given our stronger than forecasted leasing performance, we're now increased our projected year end 2010 occupancy guidance to 88%. We also expect about $0.01 of higher acquisition related expenses, with accretion from the pending acquisitions offsetting most of those costs.

After adjusting our prior guidance for these factors and further tightening the range a bit, we're now providing updated 2010 FFO guidance of $2.01 to $2.06 a share. That's the latest news from (inaudible 6-1:02) now we'll be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of John Guinee of Stifel.

John Guinee - Stifel

John, you talked a lot about replacement cost in the markets. Can you talk about what you think it costs to replace the building you just bought at first emission versus what you bought at second at Howard? And then also, the low rise building you bought in Seattle or in Bellevue?

John Kilroy

Well, I think it's San Francisco, John, if you're talking a class A building. You're going to be well north of $600 square foot depending on the height and what your land cost is.

John Guinee - Stifel

And any more color in terms of fixed building cost versus TIs versus land on that sort of product?

John Kilroy

Well, I really haven't gone through the details on either the two San Francisco replacement cost just because what we bought them for such a discount, the replacement cost, I mean I could go through and figure out all the shell and all the rest. I know that the current projections on cost in a high rise that was recently priced in the Transbay area which is a taller building is reportedly to be well north of $800 square foot.

John Guinee - Stifel

How about the Bellevue market?

John Kilroy

The Bellevue market, that particular building, we think is going to be well north of $450 per foot. One of the things that was appealing in that building beyond the position it commands with Microsoft, it's the only building they don't own in the entire area that Microsoft put in just under $100 a square foot of tenant improvements above what the base building provided.

Operator

And your next question comes from the line of Dave Rodgers of RBC Capital Markets.

Dave Rodgers - RBC Capital Markets

In the second quarter we saw that TIs were higher, can you give us some color on the recent lease signings in terms of where your office TIs and concessions would be overall, and what we should expect to see in terms of commencement with regard to the leasing that you've done in the next couple of quarters?

John Kilroy

Well, let's break that down, if I may, Dave, into two questions. The first is TI; the second is going to be starts. I'll let Tyler and Jeff deal with the latter. In terms of TI, it's all over the lot. We are just doing a deal. We just signed a letter of intent with some folks where it's a major renovation of a project, its north of a 100,000 square feet. We're putting up $10 a square foot, they're putting in many, many multiples of that. And we got a great rate.

In some cases if it's a 10 plus year lease and it's a corporate headquarters, it might be as much as $60 a square foot plus or minus.

Jeff Hawken

I think two points on the TIs and leasing commissions. You probably saw that our numbers were significantly lower in the third quarter versus the second quarter on overall renewals. We do expect that to come back up in the fourth quarter. Not as high as it was in the second quarter, but I don't think we're going to maintain the $16 a square foot or so that we had in the second quarter.

In terms of when the leasing starts, most of it starts next year. The few smaller leases that stat this year, there's one big industrial lease that does start in November of this year that will move in on '11, 01, but most of the remainder of the leasing is scattered throughout the first half of next year.

Dave Rodgers - RBC Capital Markets

Would they get other concessions? Are concessions still prevalent in the market? Can you give us some sense of market level conditions?

Jeff Hawken

It really depends from market to market, but there's still a fair amount of concessions in terms of free rent, a month, a year in term cash. We're looking for TIs on a turnkey basis to the extent they can get that. In some cases, there's just it depends what the market is. So really no change over the last quarter or two.

Dave Rodgers - RBC Capital Markets

You didn't mention equity as a profitable source for the recently announced acquisition, is that on the table as well? Or do you feel that you're well capitalized enough to continue to pursue to your opportunities in the near term?

Tyler Rose

We think we are well capitalized enough. We've raised more equity than we needed. And our leverage is sort of in the mid-30s right now. So we have some room to run on debt. And as I mentioned, we're looking on some debt opportunities right now.

Operator

And your next question comes from the line of James Sullivan of Cowen and Company.

James Sullivan - Cowen and Company

Question on the two acquisitions, John, you talked about the discounts or replacement cost and you already addressed that. And I am curious, in the prepared comments, I think Tyler might have talked about the current rent roll having a negative mark-to-market of 10%. I wonder if you could offer an opinion on the mark-to-market of the leases in place on the two acquired assets?

John Kilroy

One of the things we really assets is that in both cases, while there can be the occasion where you have a lease that is slightly above market when you look at the average, it's well below current market. So we feel we have very little roll-down exposure based upon where current rents are today in the buildings versus where current market is. Now, obviously if current market were to deteriorate further, that could create some problems.

Some of the things that we really liked about these buildings as just as we liked about 303 market, you'll recall in that building, five-sevenths of the building had been leased in the two years prior to the time that we bought it. So it had been leased right at the downturn. So we think there's very little roll down at this point in those assets.

James Sullivan - Cowen and Company

Also, you commented on the, I guess the third consecutive quarter with positive absorption in the San Diego office market, and I am curious if you can talk a little bit about where the demand is coming from within different industry groups? I know you had a good diversification among you tenant base, but by industry groups, is healthcare the primary driver?

John Kilroy

No, but it's certainly one. If there's medical products, there is healthcare providers. There is the MOB side of life, which is medical office building. And then there is software, there's financial wealth management groups; there is also a greater heading of healthcare, the pharma and life science crowd that are requiring some more space. There is, as I mentioned software, there is financial processing and there's construction, oddly enough, we've done a deal with a construction company. I think we're doing a deal with another construction company. In both cases, they're either headquarters or Western US headquarters, well capitalized companies doing massive amounts of projects not in the private sector, but in the public sector with a huge book of business.

What have I missed there Jeff? It's been very diversified of course, as we move further up, out of San Diego into L.A. and of course up to San Francisco, we start to introduce the entertainment crowds and a greater degree of Tech companies and the gaming industry and so forth.

James Sullivan - Cowen and Company

Okay. Then a question for me on the bad debt provision line, it was a positive number this quarter, I'm assuming that was a one of transaction, unlikely to be repeated next quarter?

John Kilroy

That's right.

Operator

And your next question comes from the line of Steve Sakwa.

Steve Sakwa - ISI Group

I just wanted to clarify. John, I thought you had said that you have 550,000 feet of letters of intent. And I thought I heard Tyler say 450. So I just want to clarify which one?

Tyler Rose

It's 550,000 that was my mistake.

Steve Sakwa - ISI Group

And I think, again to clarify, you said half of that was in San Diego, John?

John Kilroy

That's right. About half in San Diego, and that's all office, and half was for new leases.

Steve Sakwa - ISI Group

And just on the new side, are those new tenants for the market? Is that part of the positive absorption trend that we're seeing or is that just new to your portfolio, and these tenants are, in effect, just kind of plain musical chairs right now?

John Kilroy

Well, it's a bit of both, but I wouldn't call it in every instance if there were tenants moving from one building, Steve, into another building musical chairs because many of you written about the fact that there is dearth of new construction. And then ultimately, there will be a number of, and in fact is an increasing number of facilities that no longer meet the needs of tenants that are in them. And they are moving out to, in some cases of light to quality. In some cases, it's because they see an opportunity to step up into an asset that's better suited for their uses.

And with the health care types, sometimes that's because of changing demographics the facilities don't work for them that they've been in for some period of time, because of codes and/or other situations. So for that portion tenants, that are moving from one building to another its not always musical chairs.

Steve Sakwa - ISI Group

John, can you just comment a little bit about the occupancy drop in, I guess the L.A. Ventura County, I know you took the One Boeing building that was I believe 100% leased, but otherwise the occupancy still would have dropped I think over 200 basis points from June.

Jeff Hawken

Yes, Steve, this is a Jeff, as you point out the Boeing was a big chunk of that, we did get a little bit of space back sort of scattered from Long Beach to west L.A. on just lease expirations that we did not renew.

Steve Sakwa - ISI Group

So no particular trend?

Jeff Hawken

No, just a couple of lease expirations in various buildings, Long Beach or west L.A. so I don't think anything is a trend just the way the lease is rolled.

Steve Sakwa - ISI Group

And, John, can you just talk a little bit more about two sellers, not as a specific. But I guess in today's environment, I guess may be surprised that there'd be a lot of off market deals just given how much money seems to be kind of chasing product today. So I just don't know if you can offer us any other color about motivations behind these that these need to get done quickly or just what could you offer on that score?

John Kilroy

No, I think that you hit on it right there. In both cases that wanted absolute certainty, they wanted get done quickly, they didn't want to go to market. In one case, we had initiated conversations with somebody who knew the folks that owned the building, because we'd said that we'd like to buy more in this particular area. They then brought us together in the case up in Bellevue. Similarly, a group of individuals owned the asset, let's just say that I think they are inclined to sell in 2010 more than in 2011 for personal reasons.

And they wanted to make sure that they had a buyer that would complete that and not horse them around. And we've been looking in these areas; and this building, literally, is the only building that Microsoft doesn't own in their campus. And there is a new $30 million on/off ramp or rather a freeway overpass that's all beautifully landscaped and so forth that connects this building right into the heart of Microsoft Campus.

And so we've been looking up there and said, "Boy, if that building ever comes available" A broker who knew the guy introduced us and we were able to sit down and strike a price.

Operator

And your next question comes from the line of (Michael Eglerman of Citi).

Josh Attie - Citi

It's Josh Attie with Michael. For the acquisitions, are you assuming any secure debt with the properties?

Tyler Rose

No.

Josh Attie - Citi

And can you remind us what the target leverage is for the company?

Tyler Rose

Well, we've been in the sort of mid to high 40s for our entire history, and I think it's probably in that range.

Josh Attie - Citi

And just lastly, on the 100 First Street to get to 94% occupied, are those leases already signed or do you need to lease up that building? Is there any incremental costs related to that?

John Kilroy

Those leases are signed.

Josh Attie - Citi

So they're already in place and there's no incremental cost?

John Kilroy

Right.

Operator

And your next question comes from the line of Mitch Germain of JMP Securities.

Mitch Germain - JMP Securities

In terms of the 100 First, what's the commencement dates of taking the asset from 76% up to 94%?

Jeff Hawken

The tenant is expected to move in, in mid next year and something around early following year.

Mitch Germain - JMP Securities

And Tyler or John, can you just give some heads-up on your plan with regards to the El Segundo asset?

John Kilroy

Well, we're under a major renovation right now. The two buildings at DIRECTV is largely, and along with some other tenants. We've done those a couple of years back, and so we're similarly improving the third building, the 2260 building plus redoing the (12:02.00) areas and so forth to modernize those. And from a leasing standpoint, we have a number of proposals out ranging from the entirety of the building to floors within the building.

Operator

And your next question comes from the line of Michael Knott of Green Street Advisors.

Michael Knott - Green Street Advisors

Tyler, can you just remind me again what the price per Pound was on the two acquisitions? I just want to make sure I caught those.

Tyler Rose

On the 100 First it was $410 a foot and on the Seattle property was $377 a foot.

Michael Knott - Green Street Advisors

And the Bellevue property is a new project, newly developed? Did I catch that right or did I miss that?

John Kilroy

The building was built in 1998.

Michael Knott - Green Street Advisors

And then with respect to the possibility of asset sales, can you just give us a little more color on how you would think about it? Is there a particular market or product type that you would consider exiting? Just any color you could provide on that.

John Kilroy

Well, I don't want to get into too much color for strategic reasons with regard to some of the tenants that are in there. In some cases there are some (13.00:23) and what not. In other cases, we're having rights but it's disruptive. But let's just say that assets that are described as are not getting us to trouble with any of our tenants is something that's leased for the next 15 or 20 years, and we don't see that that adds a lot more upside other than cap rate compression.

If we're comfortable with the cap rate today that's probably a good candidate. If there's something that for other reasons we don't feel has a strategic purpose, like some of the little buildings that we acquired in our portfolio years back that are up in Northern Orange County and so forth, those would be good candidates.

So you kind of get the drift. We've got a number of those, the former category in the portfolio to the tune of several $100 million, and the question is, we'll do a very disciplined disposition. I don't think we'll throw everything on the market at once.

Michael Knott - Green Street Advisors

Okay. And then just in terms of rough potential size, it could be maybe as high as $200 million or $300 million but not necessarily that high. Is that kind of the way we should think about it?

John Kilroy

We'll provide more color on that on the next call. I don't think we want to give a specific amount on it right now.

Michael Knott - Green Street Advisors

Fair enough. And then, Tyler I know you said you are not going to raise any additional equity in conjunction with these deals given that you did earlier this year, but I forget what you may have said in the past about installing an ATM program? Is that something that you would think about?

Tyler Rose

We've thought about that over time. We haven't done that yet. We sort of like the idea, this going-to-market when we have projects to talk about. But that isn't to say we wouldn't do it. But we haven't made that decision yet.

Michael Knott - Green Street Advisors

And then last question from me. John, can you just talk about maybe your asset management and leasing strategy for the two new markets this year including Bellevue, assuming that deal does close. Can you just talk about how you intend to staff and manage those markets?

John Kilroy

In Bellevue it's a triple-net situation with tight controls like we would put on a triple-net. So Microsoft does that themselves. We obviously have to overlook. One of the things we were really impressed about that asset is, it looks brand new. I mean, literally, you could eat off any surface. It's that clean and that well maintained.

And it has a very important group that's in that particular asset. So I don't know if that's the way they treat everything, but certainly the way they treat this building. But again, it's triple-net. And our play there is basically, we think we're going to move the rent up very substantially. And ultimately over time, we'll see how successful we are in increasing our portfolio there. We're going to be very selective. We don't have any dollars that we've allocated to the Northwest or otherwise.

The overview of all that of course ultimately gets backed down to (Jeff) that will be handled. We're going through that right now as to whether we're going to handle that through an asset manager or a senior asset manager in San Francisco or whether we'll handle that through the LA office here.

As regards the San Francisco, which is the more larger portfolio and where we have now 1.2 million square feet subject to closing 100 First, we acquired through 303 Second Street a very good asset manager and a very good staff that really understands San Francisco, really understands that specific building, but also had been involved in a company that provided asset management service to a variety of buildings. We are deliberating with the asset manager on site at 100 First, and we're going to come on that.

And then right now, we're in a situation where we have an individual here who is responsible for our overall asset management activities, John Fucci, writing on those projects, and we're deliberating as to when we will hire a Regional Vice President. We've already begun some interviews.

We'll keep you informed as we make our decision. It's not in a position to at this point, but if we continue to grow in the market and we intend to or hope to, then we think we need to have a Vice President or a more senior person of asset management on the ground.

Operator

And your next question comes from the line of Chris Caton of Morgan Stanley.

Chris Caton - Morgan Stanley

My question is on 100 First, a question about your ability to kind of maintain the occupancy there. What led that to get down to 75% leased? If I'm looking at some correct data here, it looks like it's six of the top 10 floors are the vacant ones, especially as activity at the Transbay Terminal heats up over the next few years?

John Kilroy

One of the things we liked about this asset is the folks who bought it at the time, it turned out to be probably the worst possible time in buying assets there, so that they really had to suffer through the re-leasing of it in a very, very uncomfortable market and they were able to do so. And those floors that you mentioned, the building is now 94% leased. And they leased those floors at very low rates during the downturn. So we think there is tremendous upside once those leases roll.

With regard to the particular asset, there is really no material vacancy that comes up. I think it's a total maybe 30,000 feet or so that comes up over the next five or six years. And while the Transbay Terminal was well underway, we liked that because when you construction and so forth, you have disruption. The construction is supposed to be done in five to seven years. We'll be working on a park and so forth seven years out.

We think that this asset gets the benefit of being well leased during that period, comes onstream just the right time when one can really see that you've got this incredible multimodal transportation system right next door, plus a 5.5 acre park, plus all kinds of new amenities. We think it transforms the marketplace right here and particularly with regard to the adjacencies to this asset, which is right next door to Transbay and at just a world-class location. We think it will move the rates up very nicely.

Chris Caton - Morgan Stanley

To what extent did you have to get bullish in your underwriting?

John Kilroy

If you've taken a look at the office markets, I think it's CBRE that just recently came out and they put forth various rent inflation index for Manhattan, Chicago, Dallas, Los Angeles, San Francisco, Seattle, et cetera. I can tell you that the underwriting that we have is far more conservative than what that analysis puts forth. We think we are very conservative.

Chris Caton - Morgan Stanley

Given the movement in market rent, are you increasing your expected rent in 303 Second for the remaining vacancy you have there, or are you holding it at current levels?

John Kilroy

Well, we're trying to push the rent. As I mentioned in my comments, Jones Lang LaSalle reported 7% increase quarter-over-quarter in rents in the tech media area the 303 is located. So our intent is to move rents up as far as we can, and we have some strategies for that.

In addition to that, we had in our budget when we bought it money to reposition the plaza and the retail, and we have a plan that we've worked on with Gensler on that that we're now getting approval for. So we think that there are a couple of different ways to improve the economics of 303 beyond just moving the rents up. Obviously there is leasing, there is repositioning of retail, there is also some parking place that we're pursuing.

Chris Caton - Morgan Stanley

And then just one quick question on geometrics for 100 First; I think I heard it was stabilized seven yield. Is that in cash, and how long does it take to get to that seven yield?

John Kilroy

It is cash, and as I mentioned, the tenant moves in the middle of next year and then starts paying rent the following year. So it really kicks in when the tenant starts paying rent.

Chris Caton - Morgan Stanley

So like around January 1 and January 12.

Operator

And your next question comes from the line of Anthony Paolone of JPMorgan.

Anthony Paolone - JPMorgan

On your guidance for FFO for the rest of the year, it seems like it's a low end, you'd have about $0.05 roll down from your third quarter level. And so given the expectation that occupancy is trending higher and you've got some accretive deals here, just wondering what would cause you to come in towards the bottom?

Tyler Rose

We have a full quarter of the new bank line. I think the interest expense will continue to rise a little bit into the fourth quarter. And that's the primary reason. And as I pointed out, we have some acquisition costs from these deals that will be hitting in the fourth quarter which will be partially offset by the accretion from these properties but there is a little bit of that as well.

Anthony Paolone - JPMorgan

And then just on the deal pipeline. You may have touched on this, but can you breakout for us, geographically where you're seeing transactions or where most of the activity is occurring?

John Kilroy

Didn't hear the first part?

Anthony Paolone - JPMorgan

Just in terms of your deal pipeline, and what you are looking at, how does it breakout geographically?

John Kilroy

Well, it depends on how big is a pipeline you look. I mean Chris and any of those guys, Chris Corpuz, our head acquisitions, who is in the room and yes people obviously have on computer a huge number of things they track. And then we have very specific areas and assets that we obviously have a much greater interest in.

And we are tracking a number of things in San Francisco, we're tracking a number of things here in Los Angeles, and we're tracking some things down in San Diego, and then we're obviously tracking things up in the northwest as well.

But I don't really want to throw out a number, because if you add all that up, it's billions and billions and billions of dollars. And obviously, we're not going to buy billions and billions of dollars. At this point, we have signed six letters of intent to buy assets, four of them we've closed on; two of them we're now hard on. So we're very disciplined in what we buy and how we go about it. We push back from the table a number of times, far greater number than six.

When either the pricing was too rich, there was something about the asset that became apparent, didn't make it one that we wanted to own.

Anthony Paolone - JPMorgan

But there isn't anything geographically like you're seeing most of them for your activity in San Francisco for instance or somewhere else?

John Kilroy

We're consolidated right now to the west coast and the area that you've seen us announce up in the northwest, is an area we like. Right now, we're very focused in the Bay area in San Francisco. And then of course here in southern California, we're not looking at any markets that we're not now in, in the southern California area.

Operator

Your next question comes from the line of Steve (inaudible) of Cowen & Company.

Unidentified Analyst

You provided the going in yields for the acquisitions and talked about the below market nature of the leases. I was just curious what type of IRR you think you've underwritten these two?

Tyler Rose

We're sort of in the mid 9% range.

Unidentified Analyst

And what type of terminal cap grade do you provide for an increase or?

Tyler Rose

In fact our terminal cap rates are above the acquisition cap rates.

Unidentified Analyst

And the other acquisitions that I guess you guys have signed letters of intent on, would it be a similar type of IRR?

Tyler Rose

Yes, roughly.

Operator

And your next question comes from the line of Dave Aubuchon from Robert W. Baird & Company.

Dave Aubuchon - Robert W. Baird & Company

A question on the tenant that is moving into the First Plaza building to take it from 76 to 94, assuming that's one intent, one can have 80,000 square feet. Are they coming from the market, another building, or they sort of internal growth within that particular asset?

John Kilroy

First of all, it's multiple tenants.

Chris Corpuz

Most of the tenants that we're seeing 100 First are not coming from outside the market, they are coming from within the greater San Francisco area.

Dave Aubuchon - Robert W. Baird & Company

And you're that particular sub market as well or just scattered across the city?

Chris Corpuz

It depends on the lease and the floor. But I'd say generally, it's scattered from around the city.

Dave Aubuchon - Robert W. Baird & Company

John, just sort of dove tailing on the prior question about the acquisitions and where they're coming from. You've obviously been pretty successful at closing deals in San Francisco, Seattle, San Diego, Orange County.

But just sort of interesting that L.A. is just not a market where you're gaining market share. Other office REITs have been acquiring assets within that broader market. Is there a particular reason why you're not finding deals you like within L.A.?

John Kilroy

I can't get into how other folks underwrite things. I bet that was a long time, and we don't have a clearer crystal ball than anybody else. But I will tell you, that we are very rigid in the way we think about property. If we don't like the plant or the equipment or we don't feel that is going to stand the test of time, either because of its design of because something involved in the way it's constructed, it doesn't matter what the yield is.

Unless we can fix it, it doesn't matter what the yield is, we are not going to buy it. If it is a yield that doesn't meet our criteria, we're not going to buy it. If it's a location that we think it's a tweener and we think that it's going to struggle in a more difficult market, we are not going to buy it.

So by definition, we put ourselves in a position where we are not going to be able to play on those kinds of assets. Now, there are assets that have been bought that we have looked at, and either came to the conclusion we didn't like it for one of the reasons I mentioned, or we didn't like it because where the pricing got.

And I will freely admit that we have been wrong multiple times where other people saw much greater value than us; we didn't see it, and they were right and we were wrong. On the other hand, if you look back in the bubble years, there were a lot of people that saw a lot of value that if operated, and we were right, and I guess that's what makes a market. Don't think that we won't buy in the LA area. I am sort of putting a line around downtown LA and saying, we don't look there.

Don't think that we won't buy if we find the right asset. It's just that we are very disciplined and very thorough in our underwriting, and when it doesn't meet the test it doesn't get near the hoop.

Dave Aubuchon - Robert W. Baird & Company

And how close are you, do you think from transitioning from the stabilized sort of strategy to more of a value add? And it probably depends by market. Is there any market that you think maybe you are willing to take a little bit more aggressive approach?

John Kilroy

Well, we do. Like as you know, we've had a long history through the evolution of technology-type tenants. I mean, that's how my dad started the company after World War II. And if you look at what technology companies are, there is a collaborative work forces, and you see the same kinds of layouts, the same kind of improvements, the same kinds of people frankly.

And whether it's entertainment, whether that's motion picture, whether that's music, whether that's the talent scouts, as you do, and the cloud computing and the HPs and the SummerTech's and all these different hardcore technology companies, they all occupy space that looks kind of the same. And it can be a new building or can be an older rehab building. Of course, Kilroy has a particular expertise with regard to rehabs and with regard to ground-up construction. And we like and understand the technology-type companies.

So where we are seeing potential for opportunities are in some of the markets that we are now in, where we can acquire an asset and renovate it to a fashion that makes sense economically and as an appropriate risk-adjusted return because it's not just buying something that's already shiny and fixed and doing that for those types of industries that are on the go. You are not going to see us going out and buying a building that's vacant in some secondary market that is going to be a long way off before they have the job growth that will fill that asset. It's just not something that we're looking at or focused on at all.

So if you think of the areas that we're in, and you think of technology companies where there's some visible demand, you would be correct in thinking that we are looking in those areas. And I might add that in San Francisco, and I made note of this in my comments that the CAC Group who was very involved, one of the premiere office folks in San Francisco, put together an analysis. And there's basically a million square feet right now of tenants in the SoMa area, greater SoMa area south of market area in San Francisco in the tech world that are looking for space. There is already a million square feet of deals that have been done this year, and it's projected to be the biggest year ever for those types of tenants. Those people are sort of right in our wheelhouse.

Dave Aubuchon - Robert W. Baird & Company

Just two more questions. Tyler, you mentioned that you want to close these acquisitions, or said they will close by the end of the middle part of next month. Should we assume, markets willing that you want to get an unsecured debt deal dumped for the end of the year?

Tyler Rose

That's likely, yes.

Dave Aubuchon - Robert W. Baird & Company

Any particular term that you are looking at?

Tyler Rose

We did a ten-year deal earlier in the year, and we did a seven-year deal even earlier than that in the year. So a five-year deal might make sense at this point.

Dave Aubuchon - Robert W. Baird & Company

And then last question is, the note receivable that you been carrying for a while went away. I guess that's just kind of paid off?

Tyler Rose

Yes.

Operator

And your next question comes from the line of (Michael Bilerman).

Unidentified Analyst

John, just a question on the (tougher) market. And obviously having caught up with you recently, it's pretty exciting. How did you evaluate the potential risk, just in terms of public funding going for the fund Transbay, and then also the anticipated new development that would come into the market?

John Kilroy

Let's deal first with the reason Transbay was promoted by the city because they see that becoming the center piece of the 21st century San Francisco. That's why their project as such pushed over the years from the city. With regard to the $1.7 billion funding that is required for the first bay, first let's describe where the first bay is, it is the multi-modal station and all at its various levels in the retail and so forth, it's within that. And the park, it's above it, the roughly 6 acre park, it's above it.

Chris Corpuz

As is the case, is most approximately scaled, funding comes from a number of different sources. There is local, regional, state and federal money. At the local level, it's about $140 million, and they come from sources like (Crop K) the San Mateo County sales tax, AC Transit. Then at the regional level, the state level and then at the federal level with the last 400 to top it off at $1.7 billion having come from Stimulus Act.

Unidentified Analyst

But that is funded, correct?

John Kilroy

That's funded. So with regard to how we see that as a driver of that, I think that's where you're going, and in our interest in that area, this literally will be unprecedented in the west coast, you're in New York or Chicago, Boston et cetra. have your own different forms of multi-modal transportation. On the west coast, I guess LA used to when it had the old red cars back in the '30s.

And San Francisco obviously is a city that has always encouraged different modes of public transportation. In fact, most office buildings don't have any parking or very little parking and most people get to work by some form of multi-modal transportation which can be anything from a bus to a light rail, to heavy rail, the BART systems etcetera, even ferries across the water. This particular Transbay terminal will be the largest concentration of different modes of public transportation in the western United States. It is truly one of the major infrastructure projects of our time at least with regard to transportation.

It will have all of the amenities that flow from that with regard to retail restaurants etcetera. So this is going to become the epicenter in our view of San Francisco, and something that turns us very excited about. In fact some of the tenants that are located in that area in other buildings recently, because of knowing that the Transbay is going to go forward had made a decision that Gee, is where they need to be.

Now BART also is in very close proximity to 100 First. So we look at this as an opportunity. We literally went around to look at all the buildings, some of which have ownership that aren't going to sell, some might sell. And we've been trying to surprise something lose. We were successful on this one. The fact about this particular building that I really liked is that, if you think of a building having four sides, this building has a side on Mission, which is a nice exposure.

It has one that is facing on First, which is it's front door and up until the turning down right, it literally looked across the street at a 1940s, 1950s Benich building that was a continental trailways building with all the tenant source of folks that hang around those terminals. And on the south side of the building, it had an old freeway overpass that hadn't been used in years, where you literally had homeless people living underneath it, but those are now being torn down.

So just with those two things being torn down, those two horrible adjacencies, the building will go from having two wonderful adjacencies to four wonderful adjacencies in very short order, then it will go to being a ground zero, I shouldn't use that term, at the epicenter of the new transportation nucleus and it's parking would not. I think it's going to become one of the most sought after buildings in the city.

Unidentified Analyst

And just on the Boeing building of Segundo, you've put in about $51 million into that building, historical costs for the 10-K, and targeted now here another $40 million of redevelopment, so call it over $90million or $300 a foot, does that math make sense from a return perspective?

John Kilroy

You're talking about the original basis?

Unidentified Analyst

The original basis is $50 million. And so another $40 million into it, what's going to be the return on new capital versus return on total?

Tyler Rose

The incremental cost of the development is, as you point out about $40 million. A lot of that is TIs and leasing commissions for re-tenanted, almost half of that. And well, the incremental redevelopment cost is a portion of that $40 million. But the depreciated basis as you saw is about $9 million for the buildings for about 30 years ago.

Unidentified Analyst

There are substantial more within the portfolio that is still yielding reasonable on cost. I'm just trying to figure out if there are other things that we need to be mindful of where you have to spend a substantial capital to keep a return.

John Kilroy

I mean there could be on some smaller ones, but nothing to this level. What we're really doing here is we have repositioned two of the three buildings in that complex and that basically they're occupied. One is entirely occupied by DirecTV, that's about hundred and some thousand feet. The twin building 300,000 feet, DirecTV occupies by 200,000 square feet.

And what we're doing now is not only repositioning the older building, the twin it's not older, but it looks older, 2260 building to bring it up to speed, to where what we did for DirecTV and the adjacent, essentially twin building or 2250 and then have the TIs and so forth. But we're also repositioning the courtyards and the plazas and all the rest, because we think we're going to be able to drive the economics of the entire complex out pretty substantially. And I can't really get too much further into that, but let's just say that we're having some very good discussion with folks.

Operator

Thank you for your questions, ladies and gentlemen. I would now like to hand the call back to management.

John Kilroy

Thank you for your time here and your interest in KRC.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect.

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