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Kilroy Realty Bets Companies Are Ready to Get Back to the Office

Leasing Picks Up in Early 2021 as Office REIT Builds Labs, Offices

The CEO of one of the West Coast's largest office developers said tenants are ready to get back to collaborating in offices after being sidelined for more than 10 months during pandemic shutdowns.

Kilroy Realty Corp. said the pandemic and its effects on the office market upended its financial performance last year, but that's beginning to change now. 

"Based on our discussions with tenants, companies are focused on bringing their employees back together and productive in common workspaces where they can collaborate in person," Kilroy Realty Corp. CEO John Kilroy told analysts during the real estate investment trust's fourth-quarter earnings conference call. "Employees and companies want to return to work." 

Like other large office landlords, Los Angeles-based Kilroy has faced challenges as companies closed offices and sent employees to work at home when the coronavirus hit the United States early last year. Office markets nationwide slowed significantly as executives became cautious amid economic uncertainty and began to reevaluate their real estate use. 

However, the events such as the rolling out of vaccines have begun bringing hope to businesses nationwide that people may be able to gather safely again. Kilroy Executive Vice President of Leasing Rob Paratte told analysts that "the overall market sentiment throughout our portfolio is significantly more positive" this month than it was when the pandemic began. 

"In San Francisco, which has been more shut down than any city in the country, we had more leasing activity in January than last March and April," he said. 

Paratte said that with California lifting portions of its stay-at-home orders recently, prospective tenants have shown interest in some of Kilroy's vacant restaurant and retail spaces in Los Angeles and San Diego. 

Kilroy said tenants are taking a more active role in controlling their office layouts and keeping their employees and visitors healthy and safe by insisting on high-grade ventilation systems and open-floor work spaces with plenty of natural light. 

"For the largest and most influential tenants, generic office space is a nonstarter and they require an environment tailored to their specific needs," Kilroy said. 

That could provide an advantage for Kilroy Realty, which hosts some of the world's largest technology, media and life science companies across its more than 14 million-square-foot portfolio across some the top areas of Los Angeles, the San Francisco Bay Area, San Diego and the Puget Sound near Seattle. 

Kilroy's tenant roster includes Apple, Google and Netflix as well as growing biotech firms such as Vir Biotechnology, which recently snapped up a large chunk of online file-sharing company DropBox's San Francisco headquarters. 

Cautious Growth 

Of course, other real estate industry executives across the United States have been saying to investors and analysts for months on such calls that they expect office usage to start picking when the pandemic eases, and that they are taking steps to prepare for that event. But Kilroy said it can base its expectations partly on the fact that its projects now getting built are mostly leased. 

Kilroy expects to spend $275 million to $350 million on projects under construction this year, which could increase to as much as $450 million if the company is able to start the second phase of its Oyster Point life sciences complex in South San Francisco, California, this year, Kilroy's recently named CFO Michelle Ngo told analysts. 

"In the second month of 2021, we see signs of improvement in leasing," Kilroy said. "Our construction developments are largely leased and fully funded." 

Because of the strength of its tenant base, Kilroy has maintained occupancy in the mid-90% range and collected more than 98% of rent during the pandemic that has caused financial distress for many office tenants. 

Kilroy took some hits in the fourth quarter, with its overall occupancy falling to 94.3% occupancy, down from 95.5% in the prior quarter. 

The loss was mostly because of the departure of printer giant Epson America Inc., which moved its regional headquarters out of 136,000 square feet at 3840 Kilroy Airport Way in the Los Angeles County city of Long Beach to a new site a few miles away at 3131 Katella Ave. in Orange County's Los Alamito to accommodate increased growth. 

Kilroy signed just 61,000 square feet of leases during the fourth quarter as coronavirus cases surged last fall and companies backed away from making deals. Satellite broadcaster DirecTV is looking to exit part of its lease for its corporate headquarters in El Segundo, California. 

Just 3.6% of Kilroy's leases are due to expire this year and the company benefits from nearly 90% pre-leasing at its $1.6 billion in new developments under construction at favorable rents, BMO Capital Markets equity analysts Frank Lee and John Kim said in a note to clients. 

"We view Kilroy as relatively better positioned versus office peers," Lee and Kim noted, noting that just 8.8% of Kilroy's leases are expiring through 2022, the lowest among major central business district office REITs. 

Kilroy Realty reported revenue and profit increases for both the fourth quarter and full year of 2020 in spite of weakened leasing activity because of the pandemic. Total revenue of $229.3 million was up 4% in the fourth quarter from a year earlier and net income increased 8.43% to $78.6 million. 

Revenue increased 7.2% to $898.4 million and net income rose 4.4% to $195.4 million for the year.

 

Randyl Drummer   |     CoStar News     |     February 2, 2021

 

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