Good day. Welcome to the Q1 2019 Kilroy Realty Corporation earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note, today's event is being recorded. I would now like to turn the conference over to Tyler Rose, Executive Vice President and Chief Financial Officer. Please go ahead, sir.
Good morning, everyone. Thank you for joining us. On the call with me today are John Kilroy and Jeffrey Hawken, as well as other senior members of our management team who are 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. Both are also available on our website. John will start the call with an update on our market conditions and a review of the first quarter. Jeff will review operational highlights.
I'll finish up with financial highlights and a review of our updated 2019 earnings guidance that was published yesterday in our earnings release. We'll be happy to take your questions. John?
Thank you, Tyler. Hello, everyone. Thank you for joining us today. I'll begin this morning with a review of our market conditions, which continue to drive strong leasing activity. I'll summarize our first quarter results and finish with an update on our development projects. Real estate fundamentals remain strong across our West Coast markets. New supply is extremely limited. There are few land sites suitable for near-term development. Demand remains solid up and down the West Coast. We are seeing more diversified demand. It's not just technology and media, it's far more broad-based. These strong conditions have driven double-digit rent growth on a net basis across our key urban markets. Among the biggest gains, South Lake Union rents are up more than 25% year-over-year. San Francisco rents are up 15%.
Vacancy rates are now below 6% in our urban markets and hitting record lows in some areas. Bellevue is at 2.9%, San Francisco is at 4.4%, and South San Francisco is about 2.5%. With very few large blocks of space available in our key markets, we expect the upward pressure on rents to continue. In fact, we're currently experiencing record-high rents in most of our markets. Other indicators that we monitor, including job postings and VC funding, remain healthy. Seattle and the San Francisco Bay Area continue to create new jobs at the fastest rate in the nation, led by big technology. In San Diego, job postings ticked up approximately 15% over the prior quarter. Capital raising also remains strong year-over-year, driven by steady VC funding and a dramatically stronger IPO market.
We also see support for continued regional strength in the robust levels of investment that key industries are making in their future. Global research and development spending across technology and life science approached $675 billion in 2018. This level of spending is driving rapid innovation and the continued penetration of technology into the core operations of nearly all businesses. The entertainment and media industries alone are expected to generate globally more than $2 trillion in revenues this year as digital content accelerates growth across the sector. We expect this to continue. We now have Disney and Fox and others to come, expanding into content streaming. We think this will translate into significant increased demand for space. The unique characteristics of our West Coast markets continue to attract significant investor interest.
We are seeing diverse capital sources, including sovereigns, private equity, large institutional funds, and major family offices exploring purchases or joint ventures here. There is particularly strong demand for high-quality, well-located assets with low CapEx requirements. Large investors seem to be shifting their preference towards high-quality, state-of-the-art, newer assets. As investors have achieved strong returns from their West Coast investments, the region should continue to attract more capital in all forms, creating a virtuous cycle of investment and growth. We feel we're particularly well-positioned given the young age of our modern portfolio. Now let's move on to first quarter results. We delivered another strong performance. We signed new and renewing leases on just over 235,000 square feet of space in our stabilized and development portfolio, with cash rents that were up 34% and GAAP rents that were up 50% from prior levels. Our stabilized portfolio is now 96% leased.
We estimate that rents across our portfolio are approximately 20% below market, which, as we mentioned last quarter, is the largest rent differential in company history. We debuted our One Paseo mixed-use development project in Del Mar with a community opening of the retail space that is now over 90% leased and over a third occupied. With this strong momentum, we made further progress on leasing the office component, which is now more than 75% committed. We commenced construction on two life science development projects, phase 1 of Kilroy Oyster Point, a 630,000-square-foot project in South San Francisco. Our 19455 Town Center Drive building, a 160,000-square-foot project in the University Town Center submarket of San Diego. Last month, we were awarded the EPA's ENERGY STAR Partner of the Year for the sixth year in a row, as well as the EPA's highest honor, Sustained Excellence Award.
This underscores our continued commitment in sustainability and our leadership position as a global leader among all publicly traded real estate companies. In just five weeks subsequent to quarter end, we signed an additional 520,000 square feet of new leasing and renewing leases with cash rents that were up 13% and GAAP rents that were up 34%. This activity included a 154,000 square foot ten-year renewal with Lucile Packard in the San Francisco Bay Area. In addition, three of the leases were expansion leases, one with 23andMe at Oyster Point Tech Center, and the other two were in San Diego. Across these three transactions, tenants roughly doubled their existing square footage. With 23andMe expansion, we are now 100% leased at our Oyster Point Tech Center. This brings our total year-to-date leasing to over 750,000 square feet. Turning to developments, we are making good progress on all of our current projects.
In Hollywood, all components of our mixed-use project are scheduled for completion next year. Both the office and the retail space are fully leased. In Seattle at 333 Dexter, we continue to have meaningful leasing discussions and remain confident that we will be substantially leased before it's delivered later this year. In Del Mar office space, our One Paseo project is now 76% leased or committed, and marketing is underway for the residential units that will begin delivering towards the third and fourth quarter. Upon stabilization, these projects will generate an estimated cash NOI of approximately $90 million, 70% from office and 30% from residential retail. This is in addition to the projected stabilized NOI of $75 million from the three projects we have in the tenant improvement phase, including The Exchange, 100 Hooper, and One Paseo Retail.
Given our confidence in leasing at 333 Dexter and against the backdrop of strong market fundamentals and growth in the biotechnology and healthcare industries, we moved ahead with two new projects in the first quarter. At Kilroy Oyster Point, we commenced construction on phase 1 of our 40-acre life science campus situated on the waterfront in South San Francisco. This phase encompasses 630,000 square feet of lab and office space in three buildings and has a total incremental investment of approximately $450 million. We expect to deliver the project in the second half of 2021. Kilroy Oyster Point commands an extremely attractive location in one of the nation's largest and most endemic life science clusters. Near-term demand in the area exceeds 2 million square feet. Vacancy hovers at 2.5%, and existing supply is extremely limited. We are in discussions with a handful of tenants for phase 1.
In March, we commenced construction on a 160,000 square foot property in San Diego at 19455 Town Center in the UTC submarket. Our expected incremental investment in the project is approximately $95 million, with a scheduled delivery date of mid-2020. The project is situated in the heart of University Town Center in close proximity to the new San Diego trolley service and the University of California San Diego. It is a key employment center for a range of technology and life science companies. Demand for the life science in UTC submarket is very strong, with a vacancy rate of approximately 5% and limited new supply. Office fundamentals are similar, evidenced by a vacancy rate of under 4%. While we forecast this building to be occupied by a life science company, we've designed a flexible project that also appeals to office users.
As you recall, we took a similar approach to The Exchange in San Francisco, creating the opportunity to make the best decision at the appropriate time. Lastly, with regards to The Flower Mart, we expect our Prop M allocation sometime this summer. It's too soon to tell whether the four CEQA challenges will be resolved. We continue to see significant interest from a variety of large users in what is arguably one of the most sought-after commercial submarkets in the country. To fund our development, we remain committed to capital recycling. This year, we are targeting $150 million to $350 million of dispositions. We are currently in the market with two assets with a total value of approximately $150 million. To wrap up, let me reiterate our focus on three key 2019 objectives that we communicated on our February call. First, execution in our development pipeline.
During the quarter, we continued to make meaningful progress on leasing our development projects, including 333 Dexter and One Paseo, and started two new projects, Kilroy Oyster Point Phase One and our Town Center Drive building. We continue to believe that development is the best way to create shareholder value at this point in the cycle. Our focus is to ensure that our current projects deliver on time, on budget, and they achieve superior returns. We expect to make meaningful leasing progress in our development projects before year-end. Second, maximizing value in our stabilized portfolio. This includes leasing up our vacancies, deriving rents where possible, and proactively addressing expirations. Third, maintaining a strong and flexible balance sheet. This includes keeping our metrics conservative and having access to multiple forms of capital.
That completes my remarks. Now I'll turn the call over to Jeff for more detail on operations. Jeff?
Thanks, John. Hello, everyone. Since John has given you a good picture of conditions in our markets, and I know most of you follow market statistics, I will focus my comments on updating you on lease expirations and the mark-to-market rental rates across our portfolio. I'll begin with an update on lease expirations. We've made a lot of progress on our remaining 2019 expirations. We now have leased approximately 65%, or 549,000 square feet of the 856,000 square feet of 2019 expirations. That leaves a little over 300,000 square feet, or approximately 2.5% of the core portfolio remaining this year. None of the leases exceed 25,000 square feet, and they are spread across our four regions. In total, we estimate that our 2019 lease expirations are approximately 24% below market.
As we discussed last quarter, we had two lease expirations in 2020 that exceeded 100,000 sq ft, one in Northern California and one in Southern California. Two weeks ago, we signed a renewal on the Northern California property. In Southern California, we now expect the tenant to vacate upon lease expiration in the fourth quarter of 2020. We have begun marketing of the space and plan to make good progress over the roughly 18 months before expiration. Average rents in our stabilized portfolio continue to provide upside opportunity. On a portfolio-wide basis, our estimated average in-place rents are approximately 20% below market. As John noted, the gap has never been larger in our history as a public company. By region, our in-place rents for San Francisco are approximately 31% below market, Seattle is 14% below market, San Diego is 8% below market, and Los Angeles is about 12% below market.
Tyler will cover our financial results in more detail. Tyler?
Thanks, Jeff. FFO was $0.95 per share in the first quarter, which includes a positive $0.03 related to the improved credit quality of a tenant for which the company took a reserve in 2018. Same store NOI grew 3.2% on a GAAP basis in the first quarter. On a cash basis, it declined 4.2%. As we previously commented, the decline was largely driven by last quarter's San Diego expirations, as well as downtime from the Amazon lease in Seattle and downtime related to the Cruise and Dropbox leases in San Francisco. At the end of the first quarter, our stabilized portfolio was 92.5% occupied and 96.2% leased. Moving to the balance sheet, in February, we repaid a $74 million mortgage note at par that was due in June 2019.
In March and April, we sold approximately 1.2 million shares, structured as 12-month forward agreements under our ATM program, at a weighted average price of $75.92. To date, we have not settled on these nor the 5 million forward shares sold last August. At this time, we expect to settle the 5 million shares in July. We currently have $465 million available on our credit facility, which is expandable by $600 million under an accordion feature. Our debt to market cap at quarter end was approximately 24%, and our debt to EBITDA was approximately 5.7 times, pro forma for the equity raises. Let's discuss our updated guidance for 2019 provided in yesterday's earnings release. To begin, let me remind you that we approach our near-term performance forecasting with a high degree of caution, given all the uncertainties in today's economy.
Our current guidance reflects information and market intelligence as we know it today. Any significant shifts in the economy, our market tenant demand, construction costs, and new supply going forward could have a meaningful impact on our results in ways not currently reflected in our analysis. Projected revenue recognition dates are subject to several factors that we can't control, including the timing of tenant occupancies. With those caveats, our updated assumptions for 2019 are as follows. Our targeted dispositions for 2019 remain in the range of $150 million-$350 million. With the commencement of construction at Oyster Point and UTC, we anticipate remaining 2019 development spending of $400 million-$500 million. We expect to commence revenue recognition on our Dropbox lease at The Exchange in 3 phases, the first phase in the third quarter, the second phase at year-end, and the third phase in 2020.
Our forecast for year-end office occupancy is between 94%-95%. We expect 3%-4% growth in GAAP same store NOI for the full year and flat results on a cash basis, with the negative impact largely incurred in the first half of the year. The impact of expensing internal leasing costs and third-party legal fees associated with the change in lease accounting remains in the $0.08-$0.10 range for the year. $0.02 of this was incurred in the first quarter. Taking all these assumptions into account, our updated 2019 earnings guidance is $3.64-$3.78 per share, with a midpoint of $3.71 per share. We are effectively increasing the midpoint of our range by $0.03 from last quarter, driven by the reversal of the bad debt provision for the improved tenant credit quality. That's the latest news from KRC.
We'll be happy to take your questions. Operator?
Thank you. We will now begin the question-and-answer session. To ask a question, you may press star then one on your telephone keypad. If you're using a speakerphone, we ask you please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Today's first question comes from Nicholas Yulico of Scotiabank. Please go ahead.
Great, thank you. I just had a couple questions here. First, on Oyster Point. Can you just talk a little more about the demand you're seeing in the market, whether market rents you think have hit close to $6 net per month? Then on the cost for the project, is there anything in the first phase that's impacted by, let's say, a higher amenity offering for tenants? Which drove up the cost per square foot for the first phase?
Hey, Nicholas, this is Tracy Murphy. I'll try to take them in the order you gave them. Demand continues to be very strong in that market, as everywhere in the Bay Area and across all of our markets, but is just beyond about 2 million feet, specific to South San Francisco. Rents, to answer your question, haven't quite reached $72 annually, but they have been squarely sort of in the 65 or mid-60s sort of range from a Class A perspective. Then total cost, I think John covered that in his comments, but the incremental spend on phase one is roughly $450 million. Call it $950 all-in for phase one. On the amenities, we will have a pretty robust amenities package consistent with expectations for a Class A project.
There will be a redundancy across phases, but we've been thoughtful to plan that sort of holistically before we committed to dollars for amenities on phase one.
Okay, that's helpful. Thank you, Tracy. John, I just want to just turn to San Francisco and the Central SoMa plan litigation, which is underway. Is your intention there still to wait for that to get resolved before you thought about starting Flower Mart, even assuming if you got Prop M allocation?
I think we could start substructure and so forth, but we'll take a look at that, Nicholas. I'm open-minded, but I want to understand what the consequences could be given this particular litigation, which is more about blocking views, not by us, of others to some existing condo owners, and then one neighborhood group. I think one of the four is going to be solved here pretty soon. We're pretty open-minded, but I'm optimistic that these things get resolved, don't go the full distance to court based upon the history in this city and based upon the history we've had elsewhere. We're not the final arbiter of what happens, but we'll keep open-minded.
I guess just one follow-up, John, is do you think that we could see more announcements that came on leasing for projects in that area, where there's already been obviously one major lease that was done while this litigation was going on? Do you think there's a chance that other tenants could take leases ahead of this being resolved because-
Yeah, I think there's a likelihood that there's going to be a really big one. That's all I'm going to say.
Okay. Thank you very much.
Our next question today comes from Craig Mailman of KeyBanc Capital Markets. Please go ahead.
Hey, guys. Tyler, I just wanted to follow up on the bad debt expense. I think 2Q 2018, you guys, I think it was $0.05 net, maybe $0.07 gross. Is there any more bad debt related to the tenant that you reversed that could come in through the balance of the year? Or is this it, you guys think?
Yeah, no, there is a couple pennies left of that reserve. That could come over time to the extent we have a different view on the tenant.
Okay. They're current on rent and everything, right?
Yes.
Okay. Just kind of bigger picture thoughts here. You guys did additional forward equity here to discount to NAV. You guys did the forward deal last year to discount to NAV. The sales market's still pretty robust, and Park Tower went at a pretty nice cap rate here. Thoughts on accelerating dispositions above your guidance versus incremental equity offerings for the stock price today?
Yeah, this is John. We look at all those things. More to come.
Okay. Would you be willing to take more dilution on equity versus the sales? I guess just big picture, I know you guys have nice yields that you're getting on the development. Does the math continue to work to take the discount and then make it up over time? Are there better alternatives to that initial dilution?
Yeah. I think we do look at both alternatives in terms of funding, and given that we had started Kilroy Oyster Point in 19455, we thought it was the right thing from a balance sheet perspective to use the ATM a bit more to help fund 2020. You're right, we look at both dispositions and equity and evaluate how best to fund our growth. In either event, what we're building and the returns we're getting are very accretive in either event. That's where we stand on that.
Okay. Then just on the forward ATM, when do you think the takedown of that roughly $100 million is?
Probably 2020. We have flexibility, we can take it down in pieces or over time. As I said in my remarks, probably July for the forward we did last year, probably 2020 for the forward we just did.
All right, great. Thank you.
Our next question today comes from Manny Korchman of Citi. Please go ahead.
Hey, everyone. Tracy, Oyster Point, as you guys build that, do you think that leasing will come sooner and be more built to suit in nature or later something like Dexter, where you have confidence that you lease that'll be closer to delivery, and so you're building more of a generic spec project? I would think of it more in the latter, Manny. The market's really healthy and conversations continue to be healthy despite how early it is, it's historically not really been a pre-leasing market. We are pretty excited about our position in that market, and as John likes to say, more to come. Maybe John specifically on 333 Dexter, I guess we keep asking the same question, it's why isn't it leased in such a hot market?
Is there anything specific that's holding things up, or is it just a matter of the tenant hasn't signed yet?
No comment.
Thanks, everyone.
Our next question today comes from John Kim of BMO Capital Markets. Please go ahead.
Thank you. At KOP, are you committed to have a life science tenant in that asset, or is there flexibility for an office user as there is at DTC?
Hey, John, this is Tracy. If you remember back to Exchange, we have a life science warm shell committed on phase 1. We think it's likely phase 1 will go life science. It does have the flexibility to accommodate either. I don't know if that gives you any clarity, but there's a lot of flexibility with the way we've designed it, intentionally.
Is there a strong preference to have it life science, just given the market, or is there greater demand or terminal value if it's an office tenant?
This is John. John, we're kind of agnostic in one sense because we're looking for what's best for value creation. On the other hand, we have multiple phases, and it makes sense for the latter phases that are likely to be life science to make the first phase life science. We've had many inquiries from the tech community, non-life science tech, and then we have, as Tracy said, a handful of significant deals that are pure life science. I think phase one is likely to be life science. We could explore other opportunities, and we will. We want to keep our options open. But we're in the unique position of having one of the few really well-located, entitled sites for lots of square footage for 2.5, 2.7 million sq ft, whatever it turns out to be there in the four phases.
More to come as we build the final phases. I think we're going to do very well in phase one with a number of life science companies that we're working with.
Okay. John, just another question on Flower Mart. There are local reports that the planning department will recommend 1.4 million sq ft to be allocated to your developments, which is a little bit less than what you have in phase one. Would you feel comfortable moving forward if you didn't get the full allocation of the phase one part of Flower Mart?
I don't really want to get into that, John, because there's a lot of negotiations going on between the city and the various developers and so forth, and I don't think it's prudent to answer that at this time.
Understood. Thank you.
Our next question today comes from Dave Rodgers of Baird. Please go ahead.
Yeah, John. Wanted to follow up on the asset sales. You did a good job in your comments talking about the demand for the highest quality assets and the net leased buildings. What are you comfortable taking to market? You said you've got a couple in the market now. Would these be more non-core, or are you going to sell some of the better assets in the portfolio? How do you think about that today?
Yeah. Well, remember, to the issue of funding, just generally because dispositions typically are a source of funding for our either acquisition or development, as the case may be. As you know, there's debt, there's equity, there's joint venturing, either of recapping existing assets or development joint venturing, of course, there's dispositions. We've tried to make it clear over the years that we look at all four of those things in sort of harmony and what is the best for us at any particular time. Specific to the range, we've given a range of 150 to 300, or 450 was it? 350, excuse me. Too many numbers in my head today. We're very confident on the 150. We're assessing a couple of other projects.
There was one that we thought we would sell, when we really drilled down into it, we think there's big upside given where rents have gone and where demand is, and we think there's probably 25%, 30%, maybe as much as 50% more value if we do some lease things in that one particular asset. I can't give you specifics at this point, but we are not going to sell. I don't see us selling any particularly strong core assets at this point other than one of the ones that's in the current 150. We got a long year ahead of us. We have a lot of initiatives.
I'm agnostic, to tell you the truth, although when I see the rent increases that we're getting, for an example, here in San Francisco, deals that we did just a couple of years ago or a year and a half ago, now we're at rents that are might be a third under today's market in a market that's likely to escalate by another 20%, 30%, 40% over the next few years. Those obviously wouldn't be great candidates. The acceleration in the market rents and demand for space is making our calculation as to what assets to select to dispose of a little bit more difficult.
I appreciate all that added color. Maybe shifting to One Paseo, the office leasing activity that you've done there. Any more color that you can give on that, and then the demand for the remainder of the space that you have under construction there?
Sorry, was that One Paseo?
Yes. Sorry.
Yeah. Okay. You want to cover that, Rob?
Sure, Dave. This is Robert Paratte. As we said on our last earnings call, the leasing activity we've had on the office space, particularly at One Paseo, is unprecedented. I think what we're seeing in San Diego in general is similar to the trends we're seeing in our other coastal markets on the West Coast, which is that, along with FIRE category tenants, you've got technology tenants, life science tenants that are creating pressure in the market for the best-in-class office space. When you look at what One Paseo delivers to a modern tenant in terms of floor heights, light and air, that sort of thing, that's what's driving the market. Commodity space, as it always does, kind of lags the market. I think what's unique also about One Paseo particularly, is that it is mixed-use. You've got the residential. It's all going to be additive.
You've got residential, you've got this great retail where we're 96% committed now, with many of the shops open. It's just creating a synergistic effect between the three components. We're really excited about the activity we have. We're excited about the types of tenants we're talking to, and I think it bodes well for this whole Del Mar sub-market in terms of just future rent growth and absorption.
Great. Thanks. Last question from me, Jeff. The 4Q 2020 expiration, sizing on that, and how much work the building might need to re-tenant?
The one tenant that's going to be vacating in the fourth quarter 2020, it's about 135,000 sq ft. We got 18 months, so we're pretty excited about the activity, and Robert and his team are actively involved in looking for new tenants.
Okay. Thank you, everyone.
Our next question today comes from Erin Wolfe of Stifel. Please go ahead.
Hi, Great. Thank you. John Guinee here. I guess, Tracy, two quick questions. What's your fully loaded price per square foot to develop Oyster Point and UTC? How much more is that than generic office product?
Okay, let's take that. The first one on Kilroy Oyster Point, I think we kind of touched on that. The incremental spend is roughly $450, but per square foot, we're approximately $950 a foot, which is a little bit shy of where market is on a competitive basis, just based on our favorable land basis. We're in a good spot from an all-in cost basis on Kilroy Oyster Point. I know I'm going to rely on Michelle for the total cost of 19455. I think we quoted $95 million on an incremental basis.
Right. The price per foot is about $775. That's all in.
Yeah. Slightly different. You can see the difference of land basis and just construction costs, they're both very favorable in terms of the competitive set that they will play in, so to speak, as we lease up. Your question on just the incremental difference between office and life science. I don't know that we've said, it's pretty modest. Some structural things that we do. As you know, about Kilroy, we do a lot of big floor plates, more rigid floor to accommodate tech and density. For us, it's really modest.
Okay. Then, Tyler, I think at your Investor Day last June in New York Citi, you gave soft guidance of an ability to hit maybe $1.10 or $1.20 a square foot of share in FFO by year-end 2020. Do you still feel good about that number?
Yeah. Taking all the other changes that have occurred, like the lease accounting change, and dispositions and staying leverage neutral and all that, we still feel we're in that ballpark, yes.
Great. Thank you.
Today's final questions come from Jason Green at Evercore. Please go ahead.
Just a question on dispositions. Given disposition guidance was unchanged from a modeling perspective, can you help us understand the expected cadence of dispositions through the year?
Roughly third quarter for those.
Got it. Thank you.
Thank you. This concludes our question and answer session. I'd like to turn the conference back over to Tyler Rose for any closing remarks.
Thank you for joining us today. We appreciate your interest in KRC. Goodbye.
Thank you, sir. Today's conference has now concluded, we thank you all for attending today's presentation.