Good afternoon, and welcome to the third quarter of 2020 Kilroy Realty Corporation earnings conference call. I would now like to turn the conference over to Tyler Rose, Executive Vice President and CFO. Please, Tyler, go ahead.
Good morning, everyone. Thank you for joining us. On the call with me today are John Kilroy and several other members of our management team who will be available for Q&A. At the outset, I need to say that some of the information we will be discussing 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 eight days, both by phone and over the internet. Our earnings 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 third quarter highlights and an update on our market conditions. I will discuss third quarter financial results.
We'll be happy to take your questions. John?
Hey, thanks, Tyler, and hello, everyone. Thank You for joining us today. This is our third call during the COVID period. I don't think any of us thought at the outset that we would still be in the pandemic at this point. Having said that, we continue to perform well and remain optimistic about the future. Here at KRC, we remain focused on several key areas that position us well to play both defense and offense over the coming months and years. These include maintaining a strong financial foundation, proactively managing lease expirations in our stabilized portfolio, executing our under-construction development projects, positioning our future development for starts, working with governmental agencies to influence policy as much as possible, and preparing for a post-COVID future, which includes continuously enhancing the quality of our portfolio from a sustainability and wellness perspective.
While we believe we are doing well in all these areas, we also continue to do well both financially and operationally. Here are our third quarter highlights. We ended the quarter with $1.4 billion of liquidity. This includes the successful completion of $425 million green bond offering in August. Our under-construction development is now fully funded with cash on hand. Our high-quality tenant profile continues to demonstrate its value. Overall rent collection in the third quarter exceeded 96%, with office and life science rent collection north of 98%. These strong rent collection levels have remained consistent across the seven months of the pandemic, as our well-capitalized technology and life science tenant base continues to outperform. We continue to make progress in addressing our near-term lease expirations, signing renewal leases in our stabilized portfolio during the quarter on approximately 115,000 sq ft .
While leasing volumes were light, rental rates on these leases were up 15% on a cash basis and 34% on a GAAP basis. Our average annual lease expirations through 2023 now stand at approximately 6.5%. With the exception of a fourth quarter expiration this year, we do not have any expirations greater than 60,000 sq ft through the end of 2021. New leasing activity continues to be impacted by shelter in place regulations that make it difficult to tour. In development, our $1.9 billion of construction project remains on track with the expected delivery of the Netflix on Vine office project in the fourth quarter. When stabilized, the pipeline is expected to generate $140 million of annualized cash net operating income. That's an update on the quarter. Moving forward, while it's still early days in understanding the pandemic's lasting impact, we do see some important themes developing.
These include the physical makeup of commercial workspace in the industries that drive its use. The first theme is life science. It's not a secret that the life science industry has positively impacted by COVID, and we believe it will continue to benefit for the foreseeable future. VC investment in life science has been averaging $20 billion annually for the past five years. Healthcare expenditures have risen to approximately 20% of the annual GDP as our nation's population ages, and the FDA has become increasingly proactive in driving new drug development. The pandemic is moving more private and public investment into the sector and encouraging the creation of a range of new startups. We believe they will want to locate their labs and their talent in current life science clusters.
Looking at the West Coast markets we serve, current square footage dedicated to life science use totals about 20 million sq ft , with direct vacancy rates that range from 2%-3%. We estimate current demand in these markets at approximately 5.5 million sq f t. We've been building the capabilities to serve this market for more than two decades and are well-positioned to continue to capitalize on opportunities. Today, our pro forma life science footprint, which includes existing properties, life science capable assets, and entitled life science development, totals approximately 5 million sq ft . We have the third largest portfolio of life science and healthcare tenants among publicly traded REITs as a percentage of total base rent.
Several life science tenants within the KRC portfolio continue to do quite well, including Neurocrine, our largest San Diego tenant, that last quarter had two medicines approved by the FDA, and LabCorp, a South San Francisco tenant, that reported strong earnings last quarter, driven by increased COVID-19 testing volume. We believe our life science portfolio deserves more appreciation as it is essentially fully leased to strong tenants such as Acadia, Stanford University, 23andMe and so forth. Recent market activity highlights our portfolio's embedded value.
In addition to the strong valuation of the BioMed recapitalization, the sale of the Genesis buildings located on the west side of the non-traditional side of the 101 freeway in South San Francisco for approximately $1,275 per sq ft is a great comp for the Kilroy Oyster Point, particularly given that these buildings are not as ideally located or as modern. KOP is our 39-acre, 2.5 million sq ft life science development project in South San Francisco. We are in construction on phase I, a 650,000 sq ft project that is 100% leased and built with state-of-the-art life science infrastructure. It will have a total basis of approximately $865 per sq ft and is clearly worth substantially more today. KOP phase II through IV are fully entitled for another 2 million sq ft of lab space and office space.
We currently are seeing strong interest in KOP phase II from a variety of tenants and are looking carefully at the possibility of a phase II start sometime next year. To quantify, phase II is approximately 900,000 sq ft, and we have considerably more interest with active discussions than we do sq ft. The second theme is wellness. We've been in constant contact with our tenant base since the pandemic began. The leaders of these entities are focused on physical design, space adaptability, environmental health, safety and comfort, and increasing sq ft per worker. While some of these concerns are driven by short-term needs, we believe that workspace wellness is an issue that is here to stay.
We will see a large premium placed on office properties that can provide larger, more light-filled floor plates, greater flexibility in the layout, traffic flow, and use of interior spaces, stronger integration of workspace with the outdoor world and nature, and top-quality state-of-the-art operating systems that not only protect but enhance employees' health. Tenants will want to partner with well-capitalized landlords who are willing and able to invest in both innovative design and advanced infrastructure in their development. We believe these trends will give KRC a big competitive advantage in our markets. Our existing portfolio is among the youngest and best designed to meet these needs. We've been a leader in understanding and adopting design practices and systems that enhance the wellness of our buildings' occupants, and we now have the highest number of Fitwel certified properties of any company in the world.
We have deep experience in pursuing new development concepts that integrate the best, most innovative thinking in sustainability and wellness. We believe that these attributes make KRC a top partner of choice going forward. Let me wrap up with a few additional thoughts on today's markets and what may lie ahead. Amidst all the uncertainty in 2020, it remains clear that technology, media, and life science will still be the growth engine of our economy. Many companies in these industries continue to thrive in what is an otherwise challenging time, and the biggest concentration of these sectors is on the West Coast and in our markets. We remain confident that the cluster of intellectual capital, top-notch universities, and a good quality of life found in our markets is tough to replicate and a differentiating factor for Kilroy.
I don't have a crystal ball, but from a continued discussion with our customers, I'm fairly confident that companies, both large and small, established and startups, are going to want to bring their people together in communal workspaces when the pandemic has passed. Having been through a few cycles, I cannot stress enough the importance of leadership teams during down cycles for companies as well as municipalities. In good times, a rising tide lifts all boats, markets like these are best suited for those with high conviction, a track record of success, and the ability to adapt. Last cycle, we believe we differentiated ourselves from the competition through our entry into San Francisco and Seattle, and we look forward to the challenge of differentiating ourselves again in this cycle, and I'm confident we will. We've never been better positioned.
Our stabilized portfolio is young, modern, sustainable, and leads the world in wellness. Our expirations are limited. Our tenant base is largely healthy, well-capitalized, and poised for further growth. Our under-construction development projects are fully funded and 90% leased. Our future development pipeline is diversified across product types as well as markets and has a very attractive basis. Our balance sheet is solid with significant liquidity, low leverage, and no near-term maturities. Now I'm going to turn the call back to Tyler. Tyler?
Thanks, John. For the quarter, we reported FFO of $0.99 per share as we continue to see the positive contribution from development. Third quarter FFO benefited from a full quarter contribution of 49% of 333 Dexter in Seattle, as well as incremental GAAP revenue from the office space at our One Paseo mixed-use project in Del Mar. Third quarter FFO also included a $0.02 per share allowance related to our ongoing assessment of tenant credit and collectibility of rent. Looking at same-store operating results, cash same-store NOI increased 3.8% in the quarter, largely driven by higher rental rates and the burn-off of free rent. GAAP same-store NOI declined 1.9%, primarily due to prior year one-time payments. At the end of the third quarter, our stabilized portfolio was 92.2% occupied and 95.5% leased.
As John mentioned, in August, we completed a $425 million public offering of 12-year unsecured green bonds with an annual interest rate of 2.5%. This was our second green bond offering. We used a portion of the proceeds to fully repay our $150 million term loan facility. With those transactions completed, our liquidity today stands approximately $1.4 billion, including approximately $685 million in cash and $750 million available under our revolver. Our net debt to third quarter annualized EBITDA is 5.6 x. We are again, not providing specific earnings guidance this quarter, but I can offer the following assumptions based on what we know today that may be of use in assessing our potential earnings results for the remainder of the year. From a Proposition 15 perspective, we have made a $0.07 per share investment in defeating this property tax increase initiative.
This includes $0.03 of expenses already incurred in quarters two and three, and $0.04 that will show up in our fourth quarter G&A. We project remaining 2020 development spending to be between $100 million-$200 million. We are in advanced discussions on the sale of a building in the San Francisco Bay Area for approximately $75 million, with expecting closing later this quarter. As a side note, from a valuation standpoint, while there haven't been a lot of transactions, we've recently seen several trades at strong valuations. These include a multi-tenant building in Seattle at $1,000 per ft, a multi-tenant building in Santa Monica for $1,800 per ft , and several trades in San Francisco ranging from $1,000-$1,300 per ft. We will continue to evaluate disposition opportunities as appropriate. We remain in close discussions with our retail tenants to understand their financial condition.
As you may recall, over the last two quarters, we established a rent relief program, which included approximately 90% of our retail tenants. This had a minor earnings impact, and from a cash perspective, one month of rent deferral for these tenants is approximately $1.5 million. Non-contractual parking income totals approximately $1.5 million of NOI per month. We expect to receive about a third of this amount until the shelter-in-place rules are lifted. At One Paseo in Del Mar, as of October, we commenced revenue recognition on 59% of the 285,000 sq ft office project. We expect to commence revenue recognition on the remaining leased office space in phases throughout the remainder of this year. Also at One Paseo, in July, we delivered 146 residential units. This was the third and final phase.
As a reminder, we delivered the first phase of 237 units late last year, and the second phase, 225 units, earlier this year. In total, the 608-unit project is now 51% leased, and we've seen leasing momentum pick up over the last month. We expect commencement of revenue recognition on the Netflix On Vine office project next month. With respect to the residential portion, Living On Vine, it is on target for delivery in the first quarter of 2021. That completes my remarks, and now we'll be happy to take your questions. Operator?
We will now begin the question and answer session. At this time, we'll pause momentarily to assemble our roster. Our first question comes from Manny Korchman with Citi. Please, Mr. Manny, you may.
Thank you. It's Michael Bilerman here with Manny. John, good morning out there. I want to come back to your opening comments where you sort of talked about how this has gone on longer than all of us certainly had hoped earlier in the year. You commented that you remain very optimistic about the future. I'm wondering if you can sort of dig into that a little bit more, because it feels as though the number of tenants in your markets coming out and talking about either a permanent work from home or a hybrid solution, and also letting their employees work from anywhere in the future, despite some of the benefits that you talked about in terms of the intellectual capital, the university systems, the quality of life. That, I think that one's a little bit debatable right now on the coasts.
All of those elements, what gives you the confidence that they're going to come back to communal spaces, and how do you think those spaces are going to evolve in the markets that you operate in?
That's a long question, Michael. If I forget a few pieces in my response, please ask again. This COVID thing, nobody knew how long it was going to go, and we heard a lot about it's going to be over in how many months, and of course, it hasn't done that, and nobody knows how long it's going to go. What I'm encouraged by is we're seeing people really want to get back to work. Whether it's Kilroy or whether it's our tenants, what we're hearing is that people are going ape shit about working from home. Some people like it, for sure. We're also hearing that productivity is down 50% as a result of work from home.
That is not going to be universal to every single company, because we hear a lot of things that you do in the news and so forth, and a lot of times the headlines are pretty draconian, and then you read further on, and they say, "Well, w e had to provide the work from home until July of 2021 or whatever the date might be, because people need to make plans for their apartments.
They need to make plans for their daycare. They need to make plans. People are concerned about their workforce, so they're giving them as much flexibility as possible. With regard to the issue of quality of life, I will freely admit that the quality of life in some of the cities like L.A., in San Francisco, obviously other cities across the country, and they're basically the big liberal states or the big liberal cities, have issues, and they have to resolve them.
On a positive basis, we're now seeing the number of tents in San Francisco, which increased dramatically, now be reduced, and with plans by the city to further reduce them and to get the homeless off the streets and into shelters. That's going to take time. It's a positive thing that companies can see the cities are making progress. In L.A., they're doing the same thing. They've come out rather robustly about saying, "We're going to make shelters available. You're going to have to get off." The cities all now recognize that their revenue base is going to be totally messed up if these companies leave, and they're starting to respond to the market forces that we all learn in Econ 101. I'm optimistic about those things.
I'm always a little pessimistic about policies of politicians, because as everybody knows on this call, I hate politicians, almost universally. Nobody would hire any of these people, and yet they think they know better. Now what we're seeing in varying degrees of success, or veracity, is politicians saying, "Hey, we've got to straighten this out." That is a positive shift. What I'm also seeing is that in the case, as an example, on Prop 15, which would reverse for commercial properties, Prop 13 protection, the yes on Prop 15, so that's the bad thing, has gone from roughly a 20-point positive spread to now it's running behind no on 15.
That's been the result of a lot of people, not just in the real estate industry, but primarily getting together and raising $75, $80 million, whatever it is, to get out the reality, the real true information of what Prop 15, a yes vote would do. That coalition, I have a meeting tomorrow, or rather Friday, in my office in L.A. with some of the most powerful people in the States that want to join together. Kilroy's been one of many forces that have been promoting this to have a coalition of business people from the real estate and other industries to influence the policy makers. I haven't seen that in 20 years in California. There are some positive things.
With regard to quality of life, the quality of life in some cases has gotten better because there have been some reductions in the residential rents and so forth in some of these markets. It's a bit of fits and starts, but I'm seeing some of the green shoots that I didn't see before. We have real problems, no question about it. With regard to demand, while we are not seeing a lot of multi-tenant, unless their leases are coming due, talk about significant increases in space. We are seeing some really big deals that Rob can cover that are being transacted for in all of our markets, and we have negotiations or discussions with both tech and life science, with regard to a number of our markets in for development. Those are all positive.
I have to take a look at things as a leader of a company, hopefully as a glass half full rather than glass half empty. I'm feeling better about what I'm seeing now than I was three months ago. First you have to have people that agree there is a problem, and then that they want to work together to address the problem, and that it's vitally important to do so. That was not the reality three, six months ago. I think once this election, that's just such a mess, gets behind us, I think people will hopefully come together and not just be as divisive as we've seen in this cycle and others. Those are kind of my thoughts based upon interaction with others.
With regard to space per person, what we're hearing is that, and Rob, correct me if I'm wrong on this, that we're looking at roughly a 30%-40% increase in space per person from what the trend was pre-COVID. Who knows how that'll play out, whether we'll see 30% people work from home and then there's 30% more space per person. I can't tell you how that's going to work out. It'll work out, and we'll see it over time. Did I hopefully capture everything you asked?
Yeah. That's impressive, John. I didn't even give you a heads up on the question. Thank you for that.
You're welcome. Listen, I got to tell you that the role of the modern CEO in real estate right now has changed dramatically from what we have historically all been doing. We are now solidly in the political arena, and I'm not going to say who, but you have other calls that are some of the West Coast REITs and some of the East Coast REITs, and we're all talking, and we're all pissed, and we're taking the gloves off.
Yep. Sounds good. Thanks, John.
Yeah, you're welcome.
Our next question comes from Nick Yulico with Scotiabank. Please, Nick, go ahead.
Thanks. John, I guess, curious what your thoughts are right now about looking at pieces of the portfolio and seeing them as candidates for asset sales or additional joint ventures. You have done that in the past. You haven't bought back much stock historically. Would you look at that? I know you have a program in place. Would you consider increasing it? Even maybe, if you did some more asset sales, preserving some capital, putting it on the side to fund future development of Oyster Point, so you don't have to do, let's say, another forward equity deal right now where your stock price is.
Well, I have absolutely zero interest in selling stock at these prices. Zero. With regard to the development program, we had forecasted pre-COVID that the only development that we might start in 2021 would be Oyster Point phase II. That remains on track. We think that phase II is going to make imminent sense based upon the demand we're seeing. We're seeing very significant demand. We have early-stage negotiations and some proposals going back and forth on large blocks of space, 300,000, 400,000, 500,000 sq ft at a crack. I'm optimistic about that. As I want to point out again, I think we have a very favorable land basis at the Flower Mart and so forth, that I've always said that could be the next cycle. It may very well be the next cycle.
Because I'm not going to start at the Flower Mart without greater clarity. I think anybody that did that would be kind of foolish in a big dollar amount. With regard to asset sales, it's been really hampered by the building that we're selling in the Bay Area, it's not the city, for $75 million that Tyler mentioned. It's a great building, and it's a stabilized, fixed deal, and so the value per sq ft, I think, is around $900 or so. We'll have more of those. One of the problems we've had is you can't tour a lot of these things because of the regulations in place. That was one we actually had tours on and had in the market pre-COVID. With regard to recapping projects or with regard to upselling projects, we always look at that. I'm agnostic.
I have no mother fixation about any particular building, no matter how beautiful it is or pretty it is or jazzy it is. That's just not the way we work. We have a lot of options to do that. In terms of funding phase II, Tyler can talk more specifically about that, if that's part of your question. Did I capture everything, Nick?
Yeah, no, that's helpful. Thanks.
Yeah. Okay, great.
I guess just to follow up is on the tenant side. If you could just talk about how those discussions are going. Your renewals this quarter did have a shorter lease term, averaging 17 months. What kind of drove that? Should we think that that continues over the next couple of quarters, shorter term renewals as tenants kind of figure out what their space needs are? Then also, are you seeing any increase in sublease space within your own portfolio? Thanks.
Yeah. Rob, you want to cover those, please?
Sure. Hi, Nick. This is Rob Paratte. Good afternoon, everyone. The first part of your question relating to tenant sentiment and what's going on with renewals. Across the board and across the country, really, tenants are paying rents based on flexibility. They are looking for ways to avoid making long-term decisions while they try to figure out how to get their workforces back. As John said earlier, a lot of tenants have plans to come back in June, July, sometimes it's later summer of 2021. With that kind of lead time, it's much harder for them to predict when they're going to have their full workforces back. Flexibility is a key, and we've always worked very closely with our tenants.
Frankly, it's one of the ways we keep our renewal rates so high is working with them when the markets are very tight and finding alternatives for them. When markets have uncertainty, we also work with them. I think that the trend of short-term renewals will continue. I don't know how long that will continue, because oftentimes that kind of flexibility comes with a cost. As you look at these expirations that will happen, whether it's 17 months or 24 months or 36 months out, they are likely to be expiring in what's an improving economy, because we're not going to be in the situation we are today forever.
I always look at that as something that if I were a tenant, I'd keep my eye on, because eventually demand will increase, and when it does come back, these expirations are going to be impacted. As we've mentioned with respect to sublease space specifically in our portfolio, there is some sublease space that's been put on the market that's been well-publicized, excuse me. As Tyler's talked about on past calls, we tend to have a smaller tenant component in the Los Angeles area. We have had some sublease space occur down there. If you look at Kilroy's overall tenant base, which is extremely strong in terms of the large tech that we have. None of the large tech companies have put any sublease space on the market in our portfolio.
Okay. Thank you, Rob.
Our next question comes from Steve Sakwa with Evercore. Please, Steve, you may proceed.
Thanks. Tyler, I know you took a small charge this quarter, and as I look at the supplemental, you collected 98% or so of the rents in Q3. The 2% that sort of wasn't collected, is that sort of part of the recent write-offs, and does that sort of limit the risk going forward? Is that 2% still unaccounted for and possibly future write-offs?
In terms of the calculations, there's the quarter, and then there's October. We're still getting rents for October, so that number could go up. It's sort of a separate calculation. In terms of the reserves, we're looking at tenants who are struggling, who haven't paid. Of that $0.02 that we had a write-off on, about 60% was just setting up reserves for those tenants that we're worried about, 40% was for going to cash collection and basically writing off the straight-line rent. It was sort of split 60/40 on that basis. 50% of that was office, of that $0.02. It's broken up into a bunch of different pieces.
I guess I'm just trying to assess, I know you can't take write-offs just to generically take write-offs. I'm just trying to get a sense for the amount of other problems that you're sort of monitoring. Are you sort of, at this point, towards the tail end of that? Are there still other retailers or co-working tenants that are in the portfolio that you still have kind of some issues over?
Yeah, it's hard to say. Obviously, we hope we're at the tail end. You can see how the numbers have trended from the first quarter to the second quarter to the third quarter, down every quarter. We don't see anything else coming. There are some tenants in our portfolio, more on the retail side and the gym side that we're watching, and the co-working tenants we continue to watch. We don't anticipate a lot of problems. Those are the types of tenants we're watching.
Okay. Then, I guess, John or Rob, I don't know the last time you guys did 8,000 sq ft of new leasing. I know San Francisco has just sort of turned on the spigot to allow non-essential businesses to come back. The tech companies have obviously given people months and months, if not quarters, to get back to work. Is it your belief that until the buildings are really more at 50, 60% occupancy and you've got most of the folks back, that new leasing just remains kind of in a lull here?
Yeah, this is John. I'm sure Rob will have some comments. By the way, I'm off mute, right?
Yeah.
Yeah. Good. I have to always check. I've been talking to myself in a lot of meetings lately with mute on, so I apologize. Look, you're right, Steve. People are just now beginning to get back to work in San Francisco. Driving around, when I was in the city yesterday and the day before, there was actually traffic, and there were not nearly as robust a number of people walking around the streets, but there were people walking around the streets. A month ago, you could fire a cannonball down the streets and likely not hit a car. There was traffic on the 101 freeway going over the Golden Gate Bridge. There was traffic over the Bay Bridge and so forth. There was traffic in Oakland when I went to the airport the other day. Haven't seen that in months.
It is improving, and with this now ability to go to 25% workforce in San Francisco, people are going to get back to work. I think it's going to change, but it's not going to happen overnight. There's still a fear about COVID, right? Some people don't seem to have any fear, some people seem to have a lot of fear. It's going to take a while. There's not enough data to make any trend. You just kind of have to look at this as gut feel. I think it's positive. I think we'll probably see, in some municipalities, subject to the numbers of new cases and so forth, a relaxation post the election. There's a lot of people playing games with politics here. More to come.
Rob, I don't know if you have anything to add to that.
Yeah, John. Steve, the only thing I'd add to that is that if you go back to May and June, corporate real estate executive sentiment was, I wouldn't say negative, but they were very concerned because they were looking at a tidal wave coming at them, which is how do we bring people back to work? They were thinking people would be back by June or July, and they just had this tsunami coming at them. Today, they have plans in place. Every company we're talking to has some form of plan in place. They're actually, in a lot of cases, bringing people back into the office, smaller groups of people that have been asking to come in.
I think once sentiment gets to that point that we're talking about now, where they can take their eye off the how do we get people back in, I do think you're going to start seeing, especially the larger companies, look at how to secure longer-term requirements. I can't name names, but a company that we know pretty well has hired 1,000 engineers. That's 1,000 engineers.
Since COVID started. They're going to need to put those engineers somewhere. In Hollywood, production is back on stage again. You've got Sony and Netflix in production, and for every production job, the statistic is there's seven jobs that are ancillary or support jobs. That's going to start impacting, we think, demand for office space there. Then lastly, life science hasn't missed a beat. In fact, there's more demand for life science and discussions in life science going on throughout our markets, which is really exciting for us to be working on.
Okay, great. Last question, John. You mentioned Flower Mart probably next cycle at this point. I just want to make sure, are there any issues or requirements on Kilroy that kind of start at some point, given that you've got your Prop M or at this point you've got your allocation and now it just becomes when it's economical for you to start?
Yeah. Well, we have a development agreement unlike most others, and we have a longer period of time within which to start, and with starting is basically starting a foundation or something. I'm not worried about any restriction or prohibition with regard to any potential delays we have. The city, if you think about it, has counted on billions of dollars of revenue and tens of thousands of jobs from Central SoMa. Of course, they've built the Central SoMa subway and have other things that are planned, including massive amounts of development fees from the Flower Mart and other projects in the area. They want to make sure they get that revenue at some point. It's vitally important to them to fund affordable housing and transportation and so forth. I have no doubt they're going to be very cooperative with others as well.
I don't have that concern, Steve.
Okay, great. Thanks.
You're welcome.
Our next question comes from Craig Mailman with KeyBanc Capital Markets. Please, Craig, go ahead.
Hey, guys. Clearly, life science continues to be a strong suit for the office sector. You guys have some projects ready to go, and there's been a lot of talk about conversions. Are you guys concerned at all about an uptick in supply here in the near to medium term with everyone kind of getting in on the game?
You want me to touch on that, John?
Oh, maybe I'm mute now.
Craig, I'll handle that. A lot of the conversions that are going on are not They're just that, they're conversions. Entrepreneurs are taking what was designed as an office building, and some of it is older product. In fact, a lot of it's older product, and repurposing it into what they hope will be a successful life science project. That's a difficult road to go down. The ceiling heights, the capacities of the mechanical and HVAC systems, et cetera, create a lot of problems, and modern life science companies want and can afford the best state-of-the-art facilities. The other thing I'd say is where we're seeing conversions, they are typically not in the prime markets, where we operate in Seattle, South San Francisco, or San Diego. It's definitely a trend. Life science, everyone is talking about life science across the board, across the spectrum.
Again, I think conversions are a pretty difficult, different product class than a prime life science project like Kilroy Oyster Point or our portfolio in San Diego.
That's helpful. I don't know if John is still on, but clearly he touched on that you guys made the move into San Francisco after the financial crisis and have been opportunistic in the past, and you clearly have talked in this cycle about maybe bringing your act to another market, and it seems like maybe your expertise in life science would be one area where that would translate into other markets. I'm just curious, given the lack of distress so far, I know it's been tough, but is this on the radar as a potential as this pandemic continues to unfold and maybe breaks free some opportunities that we could see you guys enter a new market for life science specifically?
John, did you come back? No. Eliott, why don't you cover that?
Hey, Craig. It's Eliott Trencher. Yeah, I'd say that is on our radar screen. We like the life science business, and we're prepared to grow in it if we see the right opportunity. Similar to what happened last cycle, where we didn't make our first acquisition until 2010, we're going to be patient. I think that we're going to look at everything and move when we think it's appropriate.
Thank you, Eliott. Just one last one. Any changes to yields on your resi projects that are under development, just given the softening in the resi market?
Yeah, it's Eliott. I'll take that one again. I think it's fair to say that rents are down a little bit from earlier this year, for sure. I think that's a reasonable assumption on your part.
Awesome. Thank you.
Our next question comes from Jamie Feldman with Bank of America. Please, Jamie, go ahead.
Great. Thank you. I think you said earlier in your comments there's some pretty large deals floating around some of the markets. Can you just provide some more color on just the size of those, the markets they're in, and maybe even the timing on when those tenants would actually do something?
Sure. Jamie, this is Rob. How are you? Starting with Seattle, over the last 45 days, there's just been a tremendous amount of activity up in that market in general. Facebook, Google, Amazon have all taken space in 2020 during this pandemic. Specific examples that have been published are Facebook buying the REI buildings in Eastern Bellevue at a really healthy cap rate or implied cap rate. Amazon has signed a 2 million sq ft lease in Bellevue. There's been some other renewal activity that gives us a very positive view on the Bellevue market. In San Francisco, as we've said, San Francisco's had the most restrictive shutdown of any city in the U.S., and we're just starting to see the 25% return to work.
The shining star has been life science, I won't go beyond what John said, which is that we have interest that exceeds the amount of space we have in phase II at Oyster Point. We're in active discussions with a variety of companies that have me feeling very optimistic about that phase, as well as just the office market or the life science market we're in in Oyster Point. The other two markets that I would say have had a lot of activity are Hollywood and Culver City. Both Netflix and Amazon and Apple and the other companies that are there have looked at expansions. In fact, Netflix has expanded by about 300,000 sq ft between Hollywood and between Burbank recently. That's a bellwether for those two sub-markets. The last thing, there's been some expansion on the west side, too.
Facebook took about 85,000 ft on the west side at Playa Vista. San Diego has, as we've said before, really come into its own. We've seen Apple in our portfolio expand down there. Large tech has discovered San Diego, and there's a lot of promising interest and activity, I would say, that's happening there. The last thing I'd say about San Diego, like South San Francisco, extremely tight life science market and a lot of demand from life science companies in the life science segments of the market in San Diego.
Okay. That's helpful. I wanted to get your thoughts on the Dropbox announcement for the Dropbox Studios layout. I'm just curious, does that change how you would be designing buildings going forward? I just want to get your reaction in terms of, is that something you think more tenants will be doing going forward?
Is John on the call? I don't want to step over John if he's on. I think, Jamie, a lot of companies are experimenting right now, and the headlines reflect that. Three, four months ago, it was people announcing permanent work from home. Even those companies that have announced it have dialed that back. What companies are really looking to do now is figure out how to adapt the workspace. Tech companies have always been flexible with their employees. They've never told them, "You have to work in a specific market." Even before the pandemic, if a Google employee wanted to work in Austin, put his hand up or her hand up, the company would accommodate that. Flexibility's always been a key.
What these companies are trying to do is figure out how to make the workspace, A, safe, even with a vaccine, but the, how to make it even more productive. Microsoft's CEO, Satya Nadella, has had a lot of quotes and articles written about him in terms of his concern with the whole work from home phenomenon and what it's doing, which is burning out people. They're working more hours. He's concerned about productivity. What they're doing with their workspace is looking at how to enhance the social capital, as he puts it, that they spent so much time building and hiring people. To get specific, it's probably more areas on a floor where there's more congregating and collaboration type space as opposed to hard fixed benches.
There have been a lot of great studies done by Gensler, who's looking at this globally, and some of the other great firms.
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Sorry, I guess I exceeded my time there.
That was a first.
Anyway. Yeah, I know. I think the operator was tired of hearing me talk. Anyway, I think you're going to see a lot of adaptation in how office space is used and how companies bring people back, and there's going to be flexibility. We know for a fact, teams that are working on a product are going to need to come into the office certain days or certain months, and how does that get accommodated when you have a team that may be global coming to a central location? A studio concept, again, I think it's almost moving toward more of a hospitality sort of layout as opposed to, as I said earlier, just hard fixed workstations or benches.
Do you think the design of The Exchange lends itself to that?
I do.
Go over it would be different?
I do. I think, one of the hallmarks of The Exchange, like Flower Mart, are the large floor plates, and that's what you really need to accommodate what I'm talking about is a large floor plate where if you have 70,000 ft, you can segment that floor into different functions and, as the architects refer to it, different neighborhoods. Different things are happening in that space. It may be different departments that are working in those different segments, or it may be, again, a team that's working on software or trying to hack a database or what have you, where it takes collaboration and complex problem solving. How does that work and flow so you're not truly segmenting the space with hard walls. You're making a space that, again, kind of fits more into the hospitality arena.
The best example I can use is how you've seen hotel lobbies modified to become gathering and meeting areas as opposed to you just check in.
Okay. All right. Great. Thanks. Sounds like we'll be talking about this for a long time. I appreciate your thoughts.
Yeah. Sure.
Just as an aside, John is trying to get back on the call, but for some technical reason, he can't. We'll just keep going, and hopefully, we'll get him back on as soon as possible. Operator, keep going.
Yeah, sure. Thank you. Our next question comes from Blaine Heck with Wells Fargo. Please, Blaine, go ahead.
Great. Thanks. Probably for Rob or John, if he comes back. Clearly, there hasn't been a lot of leasing going on, but I'm wondering if you guys can give us any sense of how much you think net effective rents have declined from pre-pandemic levels in each of your markets, and what the impact of sublease space has been on asking rents, especially in San Francisco and L.A., where you guys have the majority of your expirations next year.
Hi, Blaine. This is Rob again. The problem with net effective rents and pinpointing where they are today is that there's just not enough data. There just are no data points. There have been very few isolated new leases done during this time, particularly in the last three to four months. As John said earlier in his comments, it's just extremely tough to get things done because you're not able to be face-to-face. Specifically in San Francisco, what I'd say is if you look at the renewals that have been done recently, say in the last four to five months, Goldman Sachs exercising an option to renew at 555 California at over $117 a foot fully serviced is an indicator of the fact that trophy buildings in great locations with tenants that need to be there are not having that precipitous rent drop.
Sublease space always is trading at a discount. If you're a company and you've got everybody working from home and your lease expires in the next year or two, it probably makes sense to go fishing and see if you can sublease space to mitigate some of your losses or offset your rental expense. I always look at sublease space, whether it's in Seattle or any of our markets, and let's just focus in on San Francisco and segment it. The number right now that's reported is about 6.5 million sq ft. It's probably more like seven. If you really look at that, break that down, 80% of that's located in the financial district and mid-market area of San Francisco. Half of the sublease space in the market expires in 2023.
If you were leasing space as a tenant, you decided to put space on the market with a 2023 expiration date, there's no way you can compete with direct space or even long-term sublease space. You're going to have to significantly discount that space. What I think we'll see with some of that short-term sublease space is that it will become flex space as companies do start bringing people back and affecting social distancing in their space layouts, they may need to take, and we've heard or actually participated in some conversations on just that fact. Again, I think you really need to look at where there's the headline number, and then there's really how do you segment the sublease space. It's no doubt something we keep a very close eye on.
We keep a close eye on it with respect to our tenants, but also what's going on in the market. The last thing I'd say about our Kilroy portfolio is we really have very little space to lease on a direct basis. We've only got 6% roll through 2023, with the largest being 60,000 ft. That's portfolio wide. Again, hard to pinpoint your question, direct rent, net effective rents. I think sublease space, especially depending on the type of it, is just going to be all over the map in terms of where things get done.
Okay. Rob, thanks. Tyler, just looking at same-store cash NOI for the quarter. It seems as though the reduction in expenses was the major driver of the positive results. I just wanted to ask if all of that expense reduction was related to lower utilization in your office buildings, or whether there were any other expense savings that you think could carry forward in kind of a more normal environment.
Yeah. Actually, the reason wasn't totally related to expenses. In fact, not hardly at all, because if you noticed, tenant reimbursements were down by approximately the same amount. We just didn't recover the offset of that. It wasn't really related to expenses as much as it was related to higher rents and burn-off of free rent. There is less occupancy in the buildings, we are having less expenses, but we're not benefiting from that as much as we are benefiting from the higher rents.
Got it. Thanks.
John, are you back? No? Okay.
Our next question comes from-
Tyler, can you hear me?
Oh, yeah. Now we can hear you. Hey, John.
Okay. Sorry, everybody. I've heard more classical music and been very frustrated because I've connected now the fourth time, and I can hear everybody, but nobody could hear me until this moment. I do apologize. This is a good reflection of work from home.
Okay, Operator, keep going.
Okay, thanks. Next question comes from John Kim with BMO. Please, John, go ahead.
Thanks. Good morning. John, I wanted to follow up on your comments on life science as a COVID winner. In particular, do you have updated views on whether or not Flower Mart could be developed as a life science asset?
Well, sure. I don't know that it would make sense or not. We'll see. It's interesting. Everybody's on the bandwagon, as Rob said, about life science. If anybody knows where Richmond is in the Bay Area, it's on the east side, the northeast, kind of the north and east side of Marin. It is where Standard Oil has the big refinery, and they paid all the citizens that live there $several thousand a year because of the health concerns. There's two old malls that have failed, and they're now being marketed as life science projects that can accommodate several million sq ft. You can call a donkey a horse, but it doesn't make it a horse.
I think what we're seeing right now is everybody's trying to say life science is hot, so let's try to convert everything, let's try to redesignate every property in every city and everywhere as life science. You're going to hear a lot of that, and a lot of it's just total nonsense. With regards to the Flower Mart, sure, we could do that. I don't know that life science wants to be there, but we certainly could.
In your brief absence on the call, Eliott mentioned that you may be looking to enter other biotech markets. I'm wondering if the main rationale for that is that it would provide you some operational advantages to have a more of a national biotech platform. Do you see development opportunities on the East Coast that are as attractive as the West Coast?
I'd like to answer that, but I'm not going to because, as you know, everybody that's in life science is going to be listening to what we have to say, and I'm not going to talk about any strategic thoughts that we have. Know that we are focused on life science. We are focused on looking, and we have been looking for a number of years at a couple different markets. I don't want to be buying at the top of the market, unless we believe rents are going to go up substantially and so forth. I want to make sure that if we move into a market, that we can have a scale that allows us to do the things that we do at Kilroy well, which requires talented people and requires, as I say, the scale, to make that happen. More to come.
Nothing imminent, but we're very focused.
John Kim, just to set the record straight, I don't think Eliott said that we're actively looking at other markets. Just to be clear.
Oh, okay.
Yeah. I'm just correcting John Kim's comment.
When I say actively, I mean we are active in evaluating other markets. We are not active in executing any strategy for another market.
Right.
That makes sense. Okay. Then Tyler, you mentioned a $75 million asset sale. I was wondering if you could provide any color on the sale, whether or not it was a non-core asset, or did you just find opportunistic pricing? If you can give any guidance on the cap rate expectation on sale.
I think we've commented a little bit about it. It was a pre-COVID marketing process that was started back in earlier this year. I think John said it was around a $900 a foot transaction. We're not going to comment. We haven't closed yet. We're still under confidentiality. We hope to close here in the next month or so, and we can provide more details, but we're prevented from talking too much about the transaction until it closes.
That's fine. Thank you.
Our next question comes from Omotayo Okusanya with Mizuho. Please, Omotayo, you may proceed.
Hi. Yes, good morning to you all over there on the West Coast. John, this one's for you. Quite a few polls out there just in regards to Prop 13. The one you just mentioned is the first one I've ever heard of that has the yes votes behind the no votes. I'm just curious if you could talk to us a little bit about that poll and kind of number of pollsters that were involved in it, and why you have more confidence in that one versus some of the other polls that have kind of the Prop 13 passing.
Well, because most of the polls are slanted and I don't think accurate. The groups that we're working with have had, historically, the most accurate polls on these issues, and that's the data I'm looking at. I can't tell you what exactly the names of them are. It's a close race, for sure. This demonstrates, in California, just how screwed up it is because we have a heavily biased state government. It's all Democrat. Democrat governor, Democrat attorney general, Democrat senate, Democrat assembly. They had gone out with a description of Prop 15 that is remarkable in its color as to how it was approved by the attorney general. It misled people, and so if you read that, it sort of sounds good. Sounds like 40% is going to go to schools, some other percentage is going to go to governments.
When asked the question of the schools and of the government, "Is this money going to the pension funds, the unsustainable pension funds, or is it going to the classroom?" They will not answer. What does that tell you? As people learn more about that, it has changed. The struggle that a lot of us have that are fighting these things, is that we're fighting what I consider to be a fairly corrupt machine of misinformation to the voters. We see that same kind of thing on both sides with regard to the national election. The polls also are many times biased. I'm not a pollster, so I can't go much further than that, but we have seen this major shift. It's close, but we're seeing a gain almost every week. I'm cautiously optimistic that Prop 15 will get defeated. Cautiously optimistic.
That's helpful. Okay. Thanks, John.
I hate politicians, okay? I just tell you right now. They are the scourge of-
We know, we know.
Yeah.
Thanks, John.
Yeah, you're welcome.
Our next question comes from Daniel Ismail with Green Street. Please, Daniel, go ahead.
Great. Thank you. John, I wanted to revisit a comment you mentioned about productivity being down for those firms working from home. In your discussions with tenants, are you noticing any distinctions among industries, larger or smaller firms, or geographies where you're noticing more of those concerns regarding productivity come up?
Well, think about it. If you're in the production business and entertainment and so forth, if you can't go to work, you're not getting much done. If you're in a lot of the big tech and so forth that Rob was mentioning, what we're hearing there is that productivity is way off. As Rob mentioned with regard to the CEO of Microsoft, he's been very outspoken with regard to the sort of the social capital issue and whatnot. If you're a small company, say you're a group of consultants and you're, I'll just make it up, you're in 8,000 ft and you've got, I don't know how many employees, 20 or something. You're basically on the telephone talking to people and doing things with the computer. You probably can do that from home pretty well. It's going to be different for different kinds of companies and whatnot.
I have got to tell you a little story. We've got a woman that works for us in San Diego, and she's an executive, and she and her husband had remodeled their house, and they were there with their children, their dogs, and all the rest and thinking this was just really wonderful. A couple of months in, "Gosh, I'd like to work from home forever." After about three or four months passed, she finally could get back in the office because San Diego opened a little bit earlier with regard to the percentage you could get in. Her thing is, "I never want to work from home again as long as I live. I can't. There's no separation between work and home life. You're always on demand with everybody.
Your kids are in Zoom, your dogs are barking, your husband and you have nothing else to say. I think that the anthropologists are going to have a really interesting time 10, 20 years from now, looking back at this period. I would imagine it's going to be pretty shocking with regard to some of the damage to people socially, kids particularly, but also executives. If you look at it in the statistics, and again, I'm giving you kind of directional, I don't know the exact numbers, but I was told by the head of the psychiatry department of one of the biggest medical centers in the country that divorces are up 34%. Drug use is way up, alcoholism is way up, suicide is way up. These are all manifestations of people just being miserably unhappy.
To think that there's some kind of Pollyannaish thing that everybody can work from home and it's kumbaya is insane.
Great. Just a quick follow-up on the Long Beach expiration, any update there in terms of backfilling that space or long-term plans with that property?
Hi, Daniel. It's Rob Paratte. With regard to what we're doing at the property, we're doing a, what I would call a medium refresh, just some landscaping, lobbies, updating, that sort of thing. Specifically with respect to the vacancy, I don't want to get into a lot of detail because we have some discussions going on, but I was on a call yesterday with a very good credit company that we've been talking to. They are bringing our transaction to their executive team at the end of November. We're feeling fairly good about our prospects there. They wouldn't take all the space, but it's just an example of the demand we have there.
The problem is it's taking a long time because back to John's point and the question about productivity, it takes twice as long to get people on a phone and on a Zoom call and talk through, do we renew? Do we move? What's it cost? Getting all the different teams that have input to that decision together on a call. I personally feel good about the prospects in Long Beach. It's the best-in-class asset in that sub-market, and it's perfectly situated between L.A. and Orange County, and that's why the tenant roster we have is what it is, which is a lot of very strong national companies that have regional offices, salespeople, that sort of thing locating there.
Great. Thanks, everyone.
This concludes our question and answer session. I would like to turn the conference back over to Tyler Rose for any closing remarks. Please, Mr. Tyler.
Thank you for joining us today. We appreciate your continuing interest in KRC, and we wish you all remain healthy and safe. Goodbye.
The conference has now concluded. Thank you all for attending today's presentation. You may now disconnect.