Kilroy Realty Corp. Q4 2007 Earnings Call Transcript

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 |  About: Kilroy Realty Corporation (KRC)
by: SA Transcripts

Kilroy Realty Corp. (NYSE:KRC)

Q4 FY07 Earnings Call

January 29, 2008, 02:00 PM ET

Executives

Richard E. Moran Jr. - EVP and CFO

John B. Kilroy, Jr. - President and CEO

Unidentified Company Representativ

Analysts

Louis Taylor - Deutsche Bank Securities

Michael Bilerman - Citigroup

John Guinee - Stifel Nicolaus

Michael Knott - Green Street Advisors

Mitchell Germain - Banc of America Securities

Unidentified Analyst - Credit Suisse

Michael Knott - Greenstreet Advisers

Good day, ladies and gentlemen and welcome to the Fourth Quarter 2007 Kilroy Realty Corporation Earnings Conference Call. My name is Shiquana and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will facilitate a question-and-answer session towards the end of this conference. [Operator Instructions].

I would now like to turn the call over to your host for today, Mr. Richard Moran, Please proceed, sir.

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

Good morning everyone. Thank you for joining us.

With me today are John Kilroy, our CEO; Jeff Hawken, our COO; Tyler Rose, our Treasurer; and Heidi Roth, our Controller.

At the outset, I need to stay say 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 live cast live on our website and be 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 the year. And then I will review our key markets, and I will add financial highlights and 2008 earnings guidance, and we will be happy to take your questions.

John?

John B. Kilroy, Jr. - President and Chief Executive Officer

Thanks Rick. Hello, everyone and thanks you for joining us. While we are experiencing uncertainly in the economic and tremendous change in the capital markets, on the ground, in 2007 was actually a good year for Kilroy.

We have the benefit of the support of the economy, with positive job growth. We operated in fairly good commercial real state conditions, with generally declining vacancy rates and rising rents. And we have experienced good demand from a range of potential new tenants for the high quality campus style properties that represent the core of our stabilized portfolio and our current development.

During the year, we added more than 750,000 square feet of new office space to our stabilized portfolio, all of which is fully leased and occupied. 1.7 million square feet leased is commenced to average rents, 15% higher on the GAAP basis than expiring leases. And we expanded both our in-process development program and our long-term pipeline.

As we entered 2008, conditions in Southern California feel about the same as they were at this time… the time of our last call. That said, there is no denying the increased uncertainty even anxiety hanging in the air today. The market faced a number of political and macroeconomic headwinds going forward, and thus, uncertainty. California’s residential construction and lending industries have both been hit hard by the sharp decline in housing activity and related mortgage credit crises. More broadly, California state government is experiencing significant shortfalls, tax revenue is now forecasting a budget shortfall.

Depending on some of these problems are resolve, we could face tougher real state market conditions this year. As I mentioned on our last call, we continue to see plenty of activity in our submarkets. Potential tenants are out looking transactions are being negotiated, leases are being signed, but the time it takes to reach agreements is lengthening. And we sense the continuing caution among business decision makers.

At KRC, we are approaching the year with cautious optimism. We are not currently planning any significant changes to our game plan, but will be aggressively focused on fundamentals, strong leasing program, discipline exaction on the projects we currently have under construction, and depending on markets conditions in preleasing, we will evaluate new development starts.

With that introduction, let me review some of the highlights of the fourth quarter. It was a productive period on a number of fronts. One of our biggest transactions of the quarter occurred in December. As most of you know, we have been evaluating our position Seattle for several years, and recently marketed the Seatac office complex for sale. We received a very strong offer and closed sale right at the end of the year. The all cash purchase price was $79.3 million. Given that the project is three years old, 87% leased and held as a lease hold interest, we were very pleased with the 6.8% cap rate.

We also completed in the fourth quarter the acquisition of 23 acre land side in Del Mar where we are already the dominant landlord with 1.5 million square feet of existing fully leased office space. This is a strategic acquisition of what is considered the best remaining development site in San Diego County. This site is currently entitled for 500,000 square feet of office space and cost $88 million. Taken together, these two transactions underscore our fundamental business strategy for enhancing long-term shareholder value. And in fact, we sold a very mature portfolio of assets, located in a market no longer strategically important to KRC, at or near a market peak. We then reinvested the proceeds in a highly valuable and scarce asset in a market where we have the resources and the market position to maximize its long-term value.

It was also another strong quarter for leasing of KRC. We ended the year with 94% occupancy rate, which is at the high end of the range we discussed on our last call. We have approximately 1.4 million square feet of space expiring in our stabilized portfolio during this year, including 900,000 square feet in our industrial portfolio. We now have released to renewed it approximately 520,000 square feet of that industrial space in our serious negotiations in another 260,000 square feet.

In terms of new developments, we started in the fourth quarter our Sorrento Gateway Lot 1 project. This will be a 51,000 square feet medial office building, that has an estimated total investment of approximately $22 million. I might point out that is the only medial office property zoned in the greater market. We are seeing a lot of demand for medical office product and have several discussions currently underway to lease the property. We expect to complete construction in the fourth quarter.

With that addition, our active development and redevelopment pipeline now encompasses approximately 600,000 square feet in six projects, with delivery is schedule through the fourth quarter of 2008. The total estimated investment represented by these six projects is approximately $187 million and they are 41% leased.

Now, let’s review individual submarket conditions. In San Diego, the submarkets in which operate are currently registering active demand for office space of approximately 6 million square according to CB Richard Ellis. In Del Mar where KRC is the dominant office landlord with approximately two-thirds of the top tier Class A product, current direct vacancy is approximately 8.7%, total vacancy is 12.8%. Our stabilized properties in Del Mar market are 99.8% occupied.

In the Sorrento Mesa submarket, south of Del Mar, KRC competes in the two and three storey office market. Direct vacancy for this product type is currently 6.1% and total vacancy is 7.5%. Our stabilized properties here total approximately 109 million square feet and are currently 95% occupied. South of Sorrento Mesa, the UTC Governor Park submarket, we also compete in the two storey product type, with properties totaling 430,000 square feet of space. Current direct vacancy here is about 6.9% and total vacancy is about 11.4%. Our only vacancy is the 141,000 square feet building recently vacated by Intuit.

Along the I-15 corridor, we owned approximately 750,000 square feet of stabilized office space. The two storey product type here has a current direct vacancy rate of 8.5% and total vacancy of 10.5%. In the Class A product type direct vacancy is 17.9% and total vacancy is 20.9%. Our stabilized properties here are 79% occupied.

Moving on to Orange County, our industrial portfolio is some 3.7 million square feet. It was 94% occupied at the end of the quarter. Our largest remaining vacancy and the market is the 157,000 square foot industrial project we are rezoning to residential. The Orange County industrial market remains strong with a vacancy rate of about 4.1%. Further north, at Kilroy Center Long Beach, our seven building office campus immediately adjacent to Long Beach Airport is 94% occupied. Demand is steady with Class A direct vacancy of about 8.6% and total vacancy of about 9.5%.

Moving north, at El Segundo, our stabilized properties here are 97% occupied. Market conditions here have improved substantially over the last year as direct vacancy in the El Segundo Class A market is about 10.5% and total vacancy is 11.3%. That’s about half of where it was about two years ago.

In the L.A. market, direct vacancy is now 6.5% that’s west L.A. and total vacancy is 7.7%. Our properties in the market totaling 680,000 square feet or 99.6% occupied. Finally, the 101 Corridor market which runs through Northern Los Angeles and Southern Ventura Counties remains solid, with direct vacancy in a Class A product currently is 7.5% and total vacancy is 7.7%. Our properties here are 98% occupied.

That’s an update on our recent activities and markets Now, Dick will provide the financial results. Dick?

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

Thanks John. FFO was $0.85 per share in the fourth quarter and $3.18 for the year. Occupancy in our stabilized portfolio at the end of the quarter was 94%, up from 92.6% in the third quarter. At year-end, our office occupancy was 93.7% and our industrial occupancy was 94.7%. We expect occupancy to moderate about a point or so in the first quarter as we are currently working with Orange County industrial tenant that’s having financial difficulties. They occupy about 150,000 square feet. Vacancy in that building would impact our occupancy by 1.3%.

GAAP rents increased 16%, cash rate… rents increased 2% in the fourth quarter. For the year, GAAP rents increased 15% and cash rents were up 3% Based on our latest analysis, we believe that rent levels in our overall portfolio were about 15% below market and our 2008 expirations are about 10% to 15% under market.

Capital expenditures in the fourth quarter totaled $6.8 million. For the year, capital expenditures totaled $25.4 million. Our 2008… it should be 2007 FAD payout ratio was 82%. A medical office building start that John mentioned brings our occupied pipeline to approximately $187 million of development and redevelopment in six projects that total seven office buildings in 600,600 square feet. We spent $126 million to date on these projects.

Our balance sheet is in great shape and we continue to be conservatively leveraged. We have $419 million of debt capacity on our $550 million credit line and have only $172 million debt maturity later this year. Our balance sheet strategy during the quarter was to sell a matured non-strategic Seattle project and reinvest in a premier development site in Del Mar. The move was strategic by design since we essentially offset the cost of the Del Mar site with proceeds from the Seattle divestiture. So, the overall balance sheet impact was roughly neutral. And although, the net impact will be dilutive to the near-term reported earnings, we think that it will clearly position us for significant earnings power and value creations over time.

And now let me finish with 2008 FFO guidance. Let me start with a few comments about some items that will affect our 2008 numbers. First, we are assuming that the 150,000 square foot industrial building I mentioned earlier will go dark and be vacant for the remainder of the year. That would lower our 2008 FFO by $0.03 of share. Second, the disposition of the Seattle property will be about $0.04 dilutive to 2008 earnings. Third, we expect that the FASP will release new guidance on how restricted stock affects the weighted average share calculation. Previously, we have used the treasury stock method which results in only a portion of restricted shares being included in the share count. Under the new rules, all restricted stock would be counted even vested shares. That would have approximately a $0.02 impact on our 2008 FFO. Fourth, we expect our G&A cost to move up mainly based on stock-based compensation costs. One element of the 2008 compensation program has just been approved, but the documentation be completed later this week. Since there are other aspects of the L.A. program that haven’t been finalized, yet, we have assumed that quarterly 2008 run rate of 10 million to 10.50 million, up from 9.4 million in the fourth quarter.

And finally, we have assumed that our average occupancy this year will be in a range of 92% to 93%. That’s based on the likely industrial building vacancy I mentioned earlier and our cautious expectation that the uncertainty that’s bubbling in the economy will lengthen, releasing cycle times and moderate occupancy levels this year.

Taking all these assumptions together translates into our initial 2008 FFO guidance of $3.30 to $3.50 this year with a midpoint of $3.40 this year. That’s the latest news from here and now, we will take your questions. Operator?

Question and Answer

Operator

Thank you. [Operator Instructions].

And your first question comes from the line of Lou Taylor with Deutsche Bank. Please proceed.

Louis Taylor - Deutsche Bank Securities

Good morning guys. John, can you talk a little bit about the Del Mar purchase just on a per buildable foot there? It looks like a pretty high number. A, how did you get comfortable with it and B, if there more square footage that you can build there?

John B. Kilroy, Jr. - President and Chief Executive Officer

That’s a good question, Lou. We got comfortable with it on its own merits for the 500,000 square feet that it’s entitled for. But interestingly, we are working with the city, and working with the homeowner groups. That may very well turn into a significantly larger project. Both groups, the city and the homeowners are indicating they would like to see considerably more square footage build there. We underwrote it based upon the 500,000 and based upon where we think rents are and where they are going. So, I want to say, again, its own merits, it worked for us. At the lower end of the yield spectrum based upon current rents from what we traditionally got, but we think that moves up over time. What we are really encouraged about is that on 23 acres and at the proximity it has to retail and to residential as well as in the heart of the office market with what the homeowners and the city is saying, we are cautiously optimistic that that could turn into something many multiples of what’s currently entitled.

Louis Taylor - Deutsche Bank Securities

Okay. Thank you. And the second question is pertained to the occupancy ramp for the quarter, what were some of the deals that drove the ramp for Q4?

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

Well, we talked about in the third quarter the industrial building that we were working on and we signed that lease and they moved in on the fourth quarter, was about 144,000 square feet. That was the big… a big change.

Louis Taylor - Deutsche Bank Securities

Great. Thank you.

John B. Kilroy, Jr. - President and Chief Executive Officer

You are welcome.

Operator

Your next question comes from the line of Michael Bilerman with the Citi. Please proceed.

Michael Bilerman - Citigroup

Yes, Jonathan Litt on the phone as well. John, maybe you can elaborate a bit more on the Del Mar purchase I guess with the land basis at 177, where would you expect your sort of total construction cost to be? Where are rents today? And where would that that pencil out in terms of yield?

John B. Kilroy, Jr. - President and Chief Executive Officer

Okay. Well, total development costs depending upon lease up and so forth to that project are estimated to be in the $600 range.

Michael Bilerman - Citigroup

And where are rents today on the net basis?

John B. Kilroy, Jr. - President and Chief Executive Officer

Rents today in that market, depending upon product, we are negotiating with somebody right now, we have just done a deal with somebody in the mid fours in that market. So, that would be 48 plus 6 is 54 less $8 for Op costs. And that’s for not as nice a product as we will get developed there. We think rents move up pretty substantially over the next couple of years in that market. So, based upon a 500,000 square feet, if that’s all we build, we think we are going to end up in 8% plus return on cost and 100 to 125 basis points higher on a straight line. Again, it depends on the assumptions.

Michael Bilerman - Citigroup

And then can you… the Rancho Bernardo project, I know you downsized that, as Jay Paul is already developing a multistory higher product and you are going to go more single two storey product. Can you talk about in terms of what your expected investment is now, how you foresee the timing in that project? And now given your existing land basis, how you sort of see returns evolving?

John B. Kilroy, Jr. - President and Chief Executive Officer

We have a very little cost on that projects and depending upon the amount of square footage we build. You have a different set of assumptions. What we don’t like what’s going on Rancho Bernardo now with Jay Paul and couple of others as they build Class A buildings with parking structures and so forth. In anticipation of that market, that market is not nearly as strong as like the 56 or Del Mar for corporate users. You are not going get attorneys, you are not going to get financial service firms and so forth out there. So, we have rethought our strategy. Now, I want to say that we do have somebody that we are working with and it’s for somewhere in the neighborhood of 600,000 or 700,000 square feet that is interested in that site for some particular reasons. But we felt that more conservative to look at our lower density free of parking structure scenario. And in that case, our costs are somewhere in the neighborhood of the early $400s as opposed to more like $600, when you end up with parking structures in all the rest.

Michael Bilerman - Citigroup

So, you expect you yield--?

John B. Kilroy, Jr. - President and Chief Executive Officer

And our yields based upon that somewhere in the neighborhood of the mid-eights and the mid to high nines on a straight line.

Michael Bilerman - Citigroup

And then just last question is on the two projects that are in lease up. Can you talk a little it about the negotiations that you are having there? And how you see the lease up for those assets going… what's happening in your markets?

John B. Kilroy, Jr. - President and Chief Executive Officer

Yes, I think we are going to see a good year in leasing in San Diego based upon the deals that were currently in serious negotiation and on the RPs that we are getting for existing and two meter REM [ph] projects under development. We have somewhere in the neighborhood of 500,000 square feet of pretty serious negotiations going on right now. I want to caution everybody in this kind of a climate you don’t know your going to conclude those things or not until they happen. But they are real tenants in a diverse number of industries and that is I would say 500,000 feet, that encompasses both existing products that we have is vacant and projects that we have under development all in San Diego.

Michael Bilerman - Citigroup

Okay. Thank you.

John B. Kilroy, Jr. - President and Chief Executive Officer

You are welcome.

Operator

Your next question comes from Sean Barney with Stifel Nicolaus. Please proceed.

John Guinee - Stifel Nicolaus

Well, John Guinee here, I don't know who the other one was. Okay. A few quick questions. First, when you are quoting your GAAP and cash rollouts, are you quoting on net rent or gross rent basis?

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

Well, if we're involved with the… this is Dick speaking John, both would be on a net rent basis. On an NOI basis.

John Guinee - Stifel Nicolaus

Okay. And the… and throughout your supplemental it’s net rents not gross rents?

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

Well, it depends on the market. In some markets rents are quoted differently and I think, in the supplemental, it’s fair to say we state them and quote them the way they are quoted in the market. When we quote yields we always deal with NOIs over development costs. Fully loaded development costs.

John Guinee - Stifel Nicolaus

Okay. Second, a quick question. In Europe, land inventory. What projects are you expensing and what projects are you capitalizing? The interest carried.

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

Well, right now since all of the… all of our land projects are under active development prospects and since we're marketing all of them and planning and entitling all of them. We're capitalizing interest on each of them and obviously if we stopped those efforts on any project we would stop capitalizing.

John Guinee - Stifel Nicolaus

Okay. Then there’s the last question John, to go from, on your Del Mar project to go from 177 for the land to 600 overall. What are you assuming your base building costs are and your structure parking costs are?

John B. Kilroy, Jr. - President and Chief Executive Officer

Yes. I misquoted that, when I said early 600’s, it’s in the high 600’s. The… what was the question about? Building costs?

John Guinee - Stifel Nicolaus

No. What’s going… are you building back it out--? [Inaudible] $150 a square foot what are your core and shelf costs and what are your instructed parking costs?

John B. Kilroy, Jr. - President and Chief Executive Officer

Yes it’s going to be for that site depending on how we execute it. We have the ability on that site to almost surface park it because it’s 23 acres. So, it depends whether we go with structured parking and in house structured parking. But we haven’t made that decision yet. We have a variety of alternatives in cost structures again depending upon the parking scenario.

John Guinee - Stifel Nicolaus

Okay. Thank you.

John B. Kilroy, Jr. - President and Chief Executive Officer

You're welcome.

Operator

Your next question comes from the line of Michael Knott with Green Street Advisors. Please proceed.

Michael Knott - Green Street Advisors

Hey, guys. Just curious, your outlook for share buybacks. I know it’s a question we've asked before but given the stock has continued to decline along with the REIT market. How do you view stock buyback opportunities when the implied cap rate on your portfolio is as high as 7, 7.5?

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

We've obviously been in the blackout period, still are at the moment. But beyond that I think, obviously se we've said before we've been very cautious about making sure we first preserve the integrity of our capital structure in this market but we view the current environment provide that’s very favorably in our… we’ll plan to look at that very carefully once our blackout ends.

Michael Knott - Green Street Advisors

And can you remind me if the board has currently authorized any buybacks or is that something you--?

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

Just over a million shares authorized at the current moment and in the past we've always said that we’ll be happy to go back to our board if, when and if appropriate beyond that they’re quite supportive of that concept within the framework that I just discussed.

Michael Knott - Green Street Advisors

And then, can you talk about what's going on in the I-15 market? Obviously, you're below market occupancy there and can you just talk about the prospects in that part of San Diego?

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

Yes. Obviously, if you go to the North end for us putting aside, Rancho Bernardo, we have the, what we call our innovation focus center, where we have the Scripps building under way and other buildings that are leased. We have the 103,000 I believe it is two buildings we're trading some proposals back and forth on that building right now with a well known, nationally known company and if you move further South to our Kilroy Sabre Springs project, where we have under construction a 143,000 square foot six-story building.

We have some very significant interest in that project. I can't speak much more to that and fairly adjacent to that, or one building away, we have our two-storey Sabre Springs Corporate Center. Where we have roughly 100,000 feet, which we announced last quarter that we done a deal with General Atomics for 20,000 feet. We have a number of folks that we're dealing with for that project. It's a lower cost structure than the six-storey, if you move down to Del Mar we may or may not have Paul Hastings leave roughly fifty some odd thousand square feet. That market is very strong as you know and know, and rents in that building are somewhere between 25% and 50% below current market on triple net basis.

I don’t know yet whether they are going to leave for sure. I have a number of prospects for that building. We have, if you move down the road to Sorrento Mesa, we're dealing with somebody in that market for the 50 some odd thousand square foot building we have on our Lot 3. On the medical office building that we just started, we’ve been working with brokers for the past year on that project and we feel very good about the multiple companies that are interested in that space. It’s the only zoned medical office building in the greater neighborhood, and it’s right on the freeway and then if we go down to our Governor Park project, where Intuit moved out of a 141,000 square feet.

We have two companies that are trading proposals with us right now and so we're enthused about the level of activity we have. We are enthused about the run rates that we are negotiating we just got to ink them in as we said earlier everything is taking longer. The good thing is in almost every project we're dealing with more than one company

Michael Knott - Green Street Advisors

Thank you.

John B. Kilroy, Jr. - President and Chief Executive Officer

You’re welcome.

Operator

Your next question comes from the line of Mitch Germain with Banc of America Securities. Please proceed.

Mitchell Germain - Banc of America Securities

Good afternoon, everyone. Dick if you… if you take the current run rate and add in a couple of different factors. The vacancy, the Seattle transaction. Seems like you skewed towards the bottom end of the range. What brings you back up to the 340, 350 ranges?

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

Well, I think, it would be better occupancy than we would expect and somewhat better just about its sensitivity on slightly better on everything else. But the main variable I think, in our expectation would be the occupancy.

Mitchell Germain - Banc of America Securities

Great. And you said that tenant is still occupying the asset. Correct?

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

Yes. And it’s not only that. I think, it’s the releasing cycle time is I think we all expect that to continue to be effected by the uncertainty that’s so prevalent in the macro economy. That is consistent sort of feedback we're getting from everybody we're talking to. I guess for a lack of better word, the angst about the economy.

Mitchell Germain - Banc of America Securities

But you're seeing a slowdown in demand or is it more or less just the cycle?

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

No. Not at all, as John mentioned it. That that’s sort of the paradox. We're as busy as we have been in a long time with discussions. It’s just that there is a distinct ambivalence when people look at their actual space needs. It’s very encouraging to us, when we then go through the actual discussion there is the overall macro angst as I say. And as John mentioned earlier and I think that’s the only minus where we run into in these discussions and the good news is, in the fourth quarter we came in at the high end of where we expected to be and I think we have some hope that maybe the angst passes as the year develops. It’s still there right now though.

Mitchell Germain - Banc of America Securities

Great. Thanks a lot, guys.

Operator

You have a follow-up question from the line of Michael Bilerman with Citi. Please proceed.

Michael Bilerman - Citigroup

Hey, I have two follow-ups. I know transaction activity has been scant around your markets. But can you make any comment as to cap rates, what you're seeing and how are things being underwritten?

John B. Kilroy, Jr. - President and Chief Executive Officer

We don’t see a whole lot of things being traded right now Michael. So, it’s the database I guess, you’d say is pretty scant. So, I don’t know what you can make from it. I know that we have quite a few users. That would love to buy buildings at pretty nice prices. So, I can't speak to the investment community, but we certainly read a lot about the lack of financing and so forth for some of the companies have been big buyers. But we haven’t seen that seen that transcend into a significant increase in cap rates.

Unidentified Company Representative

Right, but everybody says it may happen. We're not going to debate that. We're not clairvoyant but we knew exactly what to do each and every day. But we haven’t seen that happen.

Michael Bilerman - Citigroup

And can you just comment on the G&A and maybe drill down a little bit into the components. If you look at the ’07 plan in terms of the contribution to the G&A. if I recall it was about $0.56 for the year and then it was going to be about $0.25 impact in ’08 and so I guess, now you have an ’08 plan that has some additional contribution on top of just your normal G&A and maybe you can just sort of help us put some boxes around how you think about the overall G&A in compensation levels?

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

I guess, that I'm a little reluctant to go too far into it simply because what the feedback we've gotten so far is that we have a range of the way things might be approved because as I said earlier, there is… there are other discretionary evaluations that are taking place as to what the structure might be. So, I'm a little reluctant and just a little fearful that it might be premature. What we've done is we've taken a range of estimates as to what we think the way everything should, could come out and that’s the way we did the bandwidth, we expected it based on everything we know now to be there but I guess I'm just a little reluctant because there’s a fair amount of if then, with different alternatives. I think we’ll know a lot more in three months; we’ll be able to walk you through in detail.

Michael Bilerman - Citigroup

How different is the ’08 plan versus ’07. I mean, how is it, is there major differences of how you've approached compensation and I guess, I'm just trying to step back and try to… your overall G&A continues to rise and I was trying to understand the different components that are factoring into it and what’s really driving that increase there?

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

I think it would be premature to answer that in detail other than to say that we expect it to be primarily or essentially a stock based compensation system, which is essentially what we've had and I think some of those decisions are as to the exact… that would answer your question have not been definitively made yet.

Michael Bilerman - Citigroup

Then maybe just clarify then on the L7 plan. What the allocation was for ’07 and then what's embedded into your ’08 numbers. So that we can at least get a sense of what normal executive corporate G&A and the executive outlook from ’07 and it’s impact through the year? You previously talked about $0.50, $0.56 and that same plan contributing $0.25 in ’08 and I was just trying to make sure that those numbers are still relevant or not?

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

I believe they are… let us just confirm that to the… as far as I know nothing there has changed. I would point out that, obviously those numbers are just the way GAAP works is that we are costing out stock, in those numbers if I recall correctly, $88 a share. Obviously, just the way it works. You lock in and assume cost structure at the time that the plans are approved so the… obviously the actual value of that stock today is considerably lower, just a little more than half.

Michael Bilerman - Citigroup

Does that get adjusted for any way when the stock best delivers?

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

No, no. Once you start with GAAP you keep using the numbers when it was approved.

Michael Bilerman - Citigroup

Okay. If we can follow up, just make sure that we are understanding the…

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

I believe that… I believe that nothing has changed from those assumptions but we will confirm that for you.

Michael Bilerman - Citigroup

Okay. Thank you.

Operator

[Operator Instructions]. And your next question comes from the line of Steve Binyak [ph] with Credit Suisse. Please proceed.

Unidentified Analyst - Credit Suisse

Hi, guys. Just hoping to get some more detail on the tenants in Orange county. I am not sure whether the financial difficulties that they are experiencing will all turn out to be an isolated event or kind of a sign of future weakness in the market?

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

I think that’s the… Steve, that’s the $64 question… $64,000 question. The… at least so far that is an isolated incident, I think that you see our numbers for the fourth quarter, we took a slightly higher debt, bad debt provision and that was just in the… since we had learnt of this difficulty right at year end, beginning of this year and I think that that’s something that we have and we obviously have redoubled our efforts on our tenant watch list, we… just as anybody else would have a watch list et cetera. That is the only significant instance we have seen so far and we are obviously watching that very, very closely. The way we look at it is that we try to maintain the best relationships we possibly can with tenants. We have a… as those of you who cover us know… we have our people distributed throughout Southern California in offices that are right next to tenants, so that we can be very sensitive to the tenants needs and market to our customers with service and our market knowledge but, also we are very aware that since it is clashing with residential… the residential business where people have to write a check every month. It takes a discretionary act for a tenant not to send a check, so generally we will get advance notices, as in this case we did. The tenant was very courteous and let us know they are having some difficulty and we have been in constant contact with them, but once in a while you do just, you fail to get a check and it is one of those things, the day or two you don’t receive that at the beginning of the month, you know you have a problem and it is an instantaneous reaction. So, I know that it is more non-specific color but at least so far the only instance of note that we have is that one tenant.

Unidentified Analyst - Credit Suisse

Been factoring in those term fees for that tenant or other tenants in the ’08 guidance?

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

No. And our expectation would be that if they have financial difficulty, and we would obviously pursue our remedies, to the extent that we have them and that goes without saying, but to be conservative for the moment we have assumed that we won’t get any more rent.

Unidentified Analyst - Credit Suisse

From that or any other in ’08? I mean in terms of lease term fees?

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

Yes. Perfectly correct.

Unidentified Analyst - Credit Suisse

And then just development starts or capitalized interest new fund, further details on that in ’08?

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

In terms of development starts, I think our overall look on that is… not so good question is in this economy, we are ready, willing and able and we are proceeding with all of our planning efforts because obviously you… sometimes you can be affected and not have the ability to start for many months if you don’t keep those efforts out hard. At the same time, we… I think the way we look at the development starts is as John alluded to in his remarks, we will look at development starts on an incremental basis, based on the feedback we get from the market in terms of solid leasing prospects and/or pre leasing. It’s not to say there is an absolute requirement that we have to have x percent leasing done for anything, but we obviously in this kind of an economy with this sort of uncertainty, our planning to start more inventory or space, the medical office building in the fourth quarter was a very isolated circumstance based on the unique zoning that John mentioned for that project in that market and the encouraging response we have had from tenants. And it is small size of course but beyond that I think we are just going to let the market tell us that sooner or about development starts.

Unidentified Analyst - Credit Suisse

That feeling of development starts you have factored in your ’08 guidance?

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

Well actually that one was started in just at the end of ’07, but for the moment we don’t have any other development starts. We are planning this year… on the other hand that doesn’t all mean that we are not ready, willing and able to do that, but it’s just the … given the nature of the uncertainty in the economy we just think it is prudent to say we don’t have anything officially planned yet.

Unidentified Analyst - Credit Suisse

Thank you, guys.

Operator

You have a follow up question from the line of Michael Knott with Greenstreet Advisors. Please proceed.

Michael Knott - Greenstreet Advisers

Hi, Dick, can you give us an update on the Von Karman conversion, fourth quarter?

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

Sure. Yes. Good question. Zoning on that project continues to be… the process continues to be quite sluggish. We don’t know of any reason so far that would cause us to rethink our ultimate success in that effort. On the other hand, I guess given the nature of the process, I suppose I should underline open it. We have assumed conservatively for the moment that we don’t have that as a disposition for the year and that the building remains as is… a vacant building affecting our occupancy with us that the goose egg in it for the whole year. We, obviously still having said that working actively and aggressively with the city to perfect the re-zoning, and obviously in this market in other words tried to preserve our options throughout to go… to use either condominium or apartment product there. Obviously the expectation would be that that would be an apartment site in any kind of the economic expectations we expect in the near term.

Michael Knott - Greenstreet Advisers

Can you break out between I guess, zoning related and market related challenges of that site. Obviously the process has gone a little slower than when you first mentioned it, I think a year ago, maybe two years ago.

John B. Kilroy, Jr. - President and Chief Executive Officer

Yes. This is John. What disrupted the process is as I understand it from our people to begin with is that there are areas within the greater industrial complex, you know it well, you are down in that area in which certain industries were against seeing apartments or condos, any kind of residential abuse being dealt with. We are not in that area but the city imposed a more rigorous CIR process than had first been contemplated. That added well over a year to the process. The other thing that has been going on is that the city has is slower than molasses, far slower than… we are advised. We have a consultant who is pushing this thing for us. He is well known in that marketplace doing business with the city on this kind of conversion. So, we have got both in a bureaucracy queue as well as the bigger issue of wanting to make sure that we had a EIR that was bullet proof. So, those were the two primary things that have held it up. From a market stand point we still have folks in the apartment business that are approaching us, would like to buy the site contingent upon the zoning. Our belief has been that we are better off to be free to negotiate with multiple players once we have the zoning, we think that produces a better result for our shareholders.

Michael Knott - Greenstreet Advisers

And link it ’09 event when all this is resolved and maybe you can enter into an agreement?

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

Michael, I would have confirmed everything that we have been told by our consultant or lawyers and our people. I would have assumed that this would have happened by now. Right now we are just reluctant to put a date on it because its forces that we don’t control and we are pushing as hard as we can. It’s a relatively small project as you know on a scale of things in Orange county, but we are just keeping our fingers crossed and pushing hard to get it accomplished as soon as we possibly can. If we can get it done this year then that would be great, but for me to say it’s absolutely going to be ’09 or ’08, I just am reluctant to say that. I would suspect that we get this thing resolved this year but I suspect that we could have got it resolved last year and I was wrong.

Michael Knott - Greenstreet Advisers

Okay. And then my last question, also on Orange county industrial. I thought you said last quarter you guys were close to tightening up a lease on a main street property but it still shows vacant. What’s the update there?

John B. Kilroy, Jr. - President and Chief Executive Officer

Yes. They have leased the space and they are moving in this quarter.

Michael Knott - Greenstreet Advisers

Okay. Thanks.

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

And occupancy it just… what it does, it got delayed a little bit with the tenant improvements. That’s all.

Operator

You have a follow up question from the line of Louis Taylor with Deutsche Bank. Please proceed.

Louis Taylor - Deutsche Bank

Thanks. Dick I want to go back to the G&A question from Michael Bilerman earlier. Maybe after a different way, I mean, when you look at your G&A looks like it is going to double from ’06 to ’08 roughly. On a percentage basis how much of that is coming from… kind of normal growth in G&A and how much of it is coming from the comp plan?

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

I think Louis, if you went back to ’06 was abnormally low only because that was the odd ball here where the compensation program didn’t get approved for the year until almost the end of the third quarter, so I think if you looked over a different span of years I think the answer to your question is ’06 was quite abnormally low. I think that’s the best of my recollection on them.

Louis Taylor - Deutsche Bank

Okay. But in terms of the growth in G&A maybe we pick a little bit different number. I mean how much is it coming from just growth in normal G&A. How much of it is coming from a different comp here versus growth in the long term comp plans?

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

I… well I guess we would have to… I have to go back and since we are dealing with range this year and we have that anomaly I just mentioned I would have to get back, I don’t have it off the top of my head answer to your question.

Louis Taylor - Deutsche Bank

Thank you.

Operator

You have a follow up question from the line of John Guinee with Stifel Nicolaus. Please proceed.

John Guinee - Stifel Nicolaus

Hi. Couple of quick questions. On Von Karman, how many acres is that site and what sort of density are you trying to attain?

John B. Kilroy, Jr. - President and Chief Executive Officer

It’s 8.51 acres and in terms of density for what the apartments, is that your question?

John Guinee - Stifel Nicolaus

Yes.

John B. Kilroy, Jr. - President and Chief Executive Officer

I think it is roughly 450 apartments.

John Guinee - Stifel Nicolaus

And fair market value for an apartment site is $40,000 bucks a unit in this day and age?

John B. Kilroy, Jr. - President and Chief Executive Officer

Kent, I’m a little unwilling to say where the prices are right now because we’ve had various quotes anywhere from the $30 million to $45 million range for the property subject to design. Don’t know if those numbers still hold or not.

John Guinee - Stifel Nicolaus

Okay and then the second question John, your typical five storey product, just to get a sense of building a development budget. Is the corn shell excluding TI, is that costing you a $100, $120, $140 a square foot these days?

John B. Kilroy, Jr. - President and Chief Executive Officer

I’d be happy to follow that up with you but we include… in our cost structure… we have a very detailed matrix that we go through that may not exactly be the same boxes that you would look at. We’re happy to walk you through that in detail.

John Guinee - Stifel Nicolaus

Great. Okay. Thanks a lot.

Operator

You have a follow up question from the line of Mitch Jermaine with Bank of America Securities. Please proceed.

Mitchell Germain - Banc of America Securites

Powell. Just to confirm you said that the 47,000 square foot industrial site was going to be occupied this quarter?

John B. Kilroy, Jr. - President and Chief Executive Officer

That’s right. They’re moving in March I believe.

Mitchell Germain - Banc of America Securites

Okay. So, net, net if we do lose the 150, we gain the 47 or so?

John B. Kilroy, Jr. - President and Chief Executive Officer

That’s correct.

Mitchell Germain - Banc of America Securities

Okay. Thanks.

John B. Kilroy, Jr. - President and Chief Executive Officer

And also we leased the 90,000 square foot building in San Diego, a quarter or so ago . They would also be moving in the first quarter.

Mitchell Germain - Banc of America Securities

Great. Thank you very much.

John B. Kilroy, Jr. - President and Chief Executive Officer

Which we have already talked about.

Mitchell Germain - Banc of America Securities

Yes. Thanks.

Operator

At this time there are no further questions. I would now like to turn the call back over to Mr. Richard Moran for closing remarks.

Richard E. Moran Jr. - Executive Vice President and Chief Financial Officer

Thank you all very much for your time and your interest in KRC. We will talk to you next quarter.

Operator

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

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