Good afternoon, welcome to the second quarter Kilroy Realty Corporation earnings conference call. All participants will be in 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 this event is being recorded. I would now like to turn the conference over to Tyler Rose, Executive Vice President and Chief Financial Officer. Mr. Rose, please go ahead.
Good morning, everyone. Thank you for joining us. On the call with me today are John Kilroy, Jeff Hawken, Steve Rosetta, Heidi Roth, Tracy Murphy, Rob Paratte, Elliott Trencher, and Michelle Ngo. 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 a review of the second quarter. Jeff will discuss conditions in our key markets.
I'll finish up with financial highlights and a review of our updated 2018 earnings guidance that was published yesterday in our earnings release. We'll be happy to take your questions. John?
Thanks, Tyler, hello, everyone. Thank you for joining us. We continue to see very healthy conditions across our West Coast markets, with the second quarter setting an all-time high for us in terms of leasing volume. We signed new or renewing leases on more than 1.3 million square feet in our stabilized portfolio, with rents up 30% on a GAAP basis and 10% on a cash basis. We leveraged the strength of our existing portfolio to create a new 375,000 square foot headquarters for GM Cruise, combining buildings in San Francisco's most sought-after technology corridor into an urban campus. We made substantial progress in backfilling our major 2018 and 2019 lease expirations. We have commenced tenant improvement work on both 100 Hooper, our 400,000 square foot project in SoMa, and The Exchange, our 750,000 square foot project in Mission Bay.
We completed our acquisition of Kilroy Oyster Point, a premier waterfront life science development opportunity located in South San Francisco, and we are making progress on all our capital recycling plans. We are now non-refundable on the sale of a Bay Area office campus for $160 million. Let's get into the details. Our second quarter leasing activity hit record levels with improving fundamentals in each of our markets. Transactions were spread throughout our portfolio, and negotiations were fast and efficient, some in record time. This was demonstrated by a 12-year lease we signed in June with a software company for just over 100,000 sq ft at our 250 Brannan Street property in San Francisco.
The tenant moved quickly to secure sufficient workspace to accommodate its growth plans, and rent was up substantially over the prior lease, 50% on a cash basis and 100% on a GAAP basis, generating approximately $2.5 million in higher cash NOI on a stabilized basis. The quality of this and similar transactions we've completed and the speed with which we have been able to execute them speaks volumes about the depth of demand in our markets, the competition for space among tenants, the limited availability of large blocks of space in prime locations, and the attractive value proposition offered by our properties. The evolution of our portfolio into a younger, higher quality and more sustainable set of properties is giving us what we believe is a clear advantage in the market. It's also providing an opportunity for us to adapt quickly to emerging market trends.
One example is our recent lease transaction with GM Cruise. Looking within our existing portfolio, we were able to assemble properties and combine them with an acquisition to create a compelling urban campus for GM's self-driving car unit in the heart of San Francisco's major technology corridor. The new campus encompasses three properties, two existing KRC properties, 301 and 333 Brannan, and a third, 345 Brannan, which we are under contract to acquire later this year. These three buildings are classic examples of work environments that help attract and retain the modern workforce. They have open floor plans, rooftop gardens and meeting areas, street-level integration with neighborhood retail, and fully sustainable operating systems.
We believe this transaction solidly demonstrates how we harvest opportunities within our portfolio to create meaningful value, both by increasing cash flow, stabilized cash NOI from the three buildings will increase by $5 million in 2020, and by building strong relationships with high-growth tenants. Portfolio quality has also been an important factor in our ability to backfill our large lease expirations this year and next. We have made great strides on our major 2018 to 2019 expirations. We have now backfilled nearly 70% of the four major 2018 expirations, and for 2019, we have reduced the five expirations greater than 75,000 sq ft to just one. Moving to development, as we've reported at our recent Investor Day, we completed the acquisition of Kilroy Oyster Point development site in South San Francisco.
As most of you know, we have been expanding our market presence and management expertise in life science for some time. It is a natural extension of our platform and one of the key industries driving growth and innovation in our economy. Kilroy Oyster Point covers almost 40 acres of waterfront property. The site is fully entitled for 2.5 million sq ft of office and lab space, and is located in the premier West Coast market for healthcare, life science, and biotechnology industries. It is situated on the preferred northern corridor and at the front door to the existing ferry service. The project will include four phases with a total of 11 buildings, providing flexibility and optionality in terms of timing. Phase one is currently planned for three buildings, totaling approximately 600,000 sq ft.
With regard to our ongoing development program, as I mentioned, we are in the TI phase on both 100 Hooper and The Exchange. The construction continues to progress on time and on budget on all of our projects, including 333 Dexter, Academy on Vine, and One Paseo. These three under-construction projects total just under one million sq ft of office space, 120,000 sq ft of retail space, 608 residential units. Together, they represent a total estimated investment of $1.1 billion, or approximately 10% of our enterprise value. At One Paseo, the retail component is now 70% leased, with additional transactions in varying stages of documentation that would increase this percentage to over 90%. The retail grand opening is scheduled for next spring. We have also now commenced construction on all of the remaining residential units. The apartments will be delivered in phases beginning mid-next year.
With the retail and residential components creating energy and buzz in the community, as well as providing the amenities that the modern tenant wants, prospective office tenants are now showing significant interest in our to-be-built 270,000 sq ft office project. Given the strong pre-leasing activity and market rental rates at all-time highs, combined with no competing supply, we are evaluating when we should start the office component of One Paseo. Let me finish with a quick update on capital recycling. We are now non-refundable on the sale of a multi-building campus in Northern California for $160 million. We expect to close this disposition in the fourth quarter. We are also in various stages of the sales process on several other assets and expect to be within our previously stated range for the year. To summarize, let me leave you with four messages.
First, fundamentals in our markets are strengthening, not softening, and our young, modern portfolio is ideally positioned to capture that demand. While it's difficult to forecast precisely, we and the brokerage community predict continued rent increases in all of our markets over the next few years. Second, our capital allocation strategy remains focused on development, which is both increasing FFO and creating long-term value. With the developments mentioned above, we expect FFO to grow by 25% by 2020. Third, we will stay disciplined in managing the risk of the company. Fourth, with the capital market transactions that Tyler will discuss, in addition to our ongoing dispositions, we continue to fund our growth conservatively and economically. That completes my remarks. Now I'll turn the call over to Jeff for a closer look at our markets. Jeff?
Thanks, John. Hello, everyone. Conditions in our West Coast markets remain strong. While technology, media, healthcare, and life science industries have been driving economic growth, generating new businesses, and competing for ideas and talent, we are pleased to see that there's more broad-based growth, with the FIRE category now expanding as well. The results are declining vacancy rates, rising rents, larger and longer average lease commitments, and in some cases, more rapid lease execution. Let me review each market in more detail. I'll begin in San Francisco. Large leasing activity dominated headlines, with 4 leases greater than 100,000 sq ft signed. 3 of these deals were Kilroy deals, including GM Cruise, Nektar Therapeutics, and the recent deal John discussed earlier at 250 Brannan.
Currently, there's only 1 Class A contiguous block of space greater than 100,000 sq ft remaining in the South of Market area today. Brokers are reporting that there are currently 24 companies looking for at least that much space in the city. This dynamic is reflected in vacancy rates. In San Francisco, SoMA, South Financial District, and Mission Bay districts, Class A direct vacancy rates were 2.8%, 7%, and 0.6%, respectively. In South San Francisco, the life science vacancy rate was 2%, and Silicon Valley Class A direct vacancy was 6.8%. We are currently 98.2% leased in the Bay Area. Our in-place rents for the region are approximately 31% below market. Conditions in Seattle echo that of San Francisco. Leasing activity remains robust as large blocks of space continue to be spoken for by expanding tenants.
Brokers are reporting that there are several 100,000 sq ft-plus users in the market. These tenants are currently seeking over 4 million sq ft of space. The continued strong performance in the region is reflected in the numbers, as we saw rents increase and vacancy rates continue to decline. Class A direct vacancy in both South Lake Union and Bellevue is 4%. Our Seattle portfolio is currently 95.2% leased. Our in-place rents were approximately 11% below market. In San Diego, activity has picked up significantly, driving the vacancy rate down to 10%, the lowest level since 2010. Positive net absorption totals 565,000 sq ft. Class A direct vacancy in Del Mar with the region's highest asking rents was 13.3%. Our San Diego portfolio is currently 99.2% leased, and our San Diego in-place rents are approximately 6% above market.
In Los Angeles, employment in entertainment, digital media, gaming, fashion, and related fields recently hit a 10-year high. Netflix, Amazon, and Apple have all established their own entertainment studios and are actively recruiting local talent. The state has encouraged growth by expanding film and TV tax incentives. Class A direct vacancy in West L.A. was 5.4%, West Hollywood was 7.3%, and Hollywood was 8.4%. Our Los Angeles portfolio is currently 95.2% leased. In-place rents are approximately 8% below market. On a portfolio-wide basis, our estimated average in-place rents are 16% below market. As John discussed, the record-breaking lease activity we've completed has significantly reduced our future expirations. With the completion of the 145,000 sq ft General Atomics lease in San Diego, major 2018 expirations now consist of just the second Bridgepoint building and a portion of the Del Mar Corporate Center, both in San Diego.
Of the five 2019 expirations greater than 75,000 sq ft we had last quarter, we have completed the re-leasing on four of them, leaving only a 75,000 sq ft building in Sunnyvale, where the lease rate is more than 50% below market. That's a snapshot of our markets. Tyler will cover financial results in more detail. Tyler?
Thanks, Jeff. FFO was $0.86 per share in the second quarter. There were several in and outs this quarter. First, FFO includes a $0.05 per share charge for bad debt expense, $0.07 related to one tenant with which the company is in ongoing discussions, partially offset by a bad debt reversal of $0.02 related to a lease assignment. Second, it also includes $0.05 per share of higher G&A, $0.02 primarily related to professional services fees associated with a legal matter, and $0.03 of non-cash items related to stock compensation amortization and the mark-to-market adjustment on our deferred cash program. Third, other income was up $0.03 a share from lease termination fees, although half of that was offset in revenues from the write-off of deferred rent related to those lease terminations.
With regard to the $0.07 reserve, given that we are in discussions with a tenant, we are not able to provide its name or location. We can say that this is a reserve, not a write-off, and it's possible that we could take this back over time. The tenant is still in full occupancy, but has certain credit issues, and we are de-risking our position. The space is very high quality, and rents are well below market. We hope you appreciate that this is all we can say at this time. Moving on. Same store NOI continued to grow in the second quarter, driven largely by higher rental rates. For the second quarter, cash same store increased 5.1%, and 1.7% on a GAAP basis. The GAAP number includes the bad debt expense. It's a non-cash reserve.
For the first half, GAAP NOI was up 3.6%, and cash NOI was up 5%. We were also active in the capital markets. In May, we completed a $250 million private placement of eight-year senior unsecured notes in two tranches, with three and six-month delay draw options, respectively. The first tranche was for $50 million of 4.3% notes, which we drew down earlier this month. The second tranche is for $200 million of 4.35% notes. We are required to draw these funds by mid-October. We also issued approximately $100 million of common stock in May, using the remaining capacity of our $300 million ATM program. In June, we established a new ATM program with a $500 million capacity and raised $26 million. We currently have $460 million available on our credit facility, which is expandable by $600 million under an accordion feature, for a total availability of $1 billion.
Our debt-to-EBITDA at quarter end was approximately 6.5 times, adjusted for the bad debt expense. Let's discuss our updated 2018 guidance 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 or 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 2018 are as follows. Our dispositions guidance range remains $250 million-$750 million.
We anticipate remaining 2018 development spending to be approximately $250 million-$300 million. We continue to project revenue recognition from the Adobe lease at 100 Hooper late in the fourth quarter, and no contribution from the Dropbox lease in 2018. Dropbox is expected to take occupancy in 3 phases, starting mid-next year into 2020. As we reported at our investor day, we expect that given these development deliveries funded on a leverage-neutral basis, our FFO will grow by approximately 25% by the end of 2020. While the quarter had lots of ins and outs, given stronger core results in the second quarter, including strong same store results, we're increasing our projected 2018 same store cash NOI growth from a range of 0%-1%, to a new range of 1%-2%.
We are maintaining our year-end office occupancy range of 94%-95%. We are maintaining our annual guidance, adjusted down for the bad debt reserve. Specifically, last quarter, we provided earnings guidance for 2018 of $3.49-$3.64 per share, with a midpoint of $3.57 per share. We are updating that midpoint of our guidance to $3.52 per share, with a range of $3.47-$3.57 per share to reflect the impact of the $0.05 of net bad debt expense. Higher G&A is essentially offset by the better core results. That's the latest news from KRC. I'll be happy to take your questions. Operator?
We will now begin the question and answer session. To ask a question, you may press star 1 on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star 2. First question today comes from Craig Mailman with KeyBanc Capital Markets. Please go ahead.
Good afternoon, guys. I know you're limited in what you can talk about with the troubled tenant, just curious if you could give some background on sort of what triggered you guys to take the reserve, and whether this has kind of prompted you guys to go back to the portfolio, and whether there's any more companies that are potentially on a credit watch list.
Yeah, we can't really say much more, as I said already, as I said in my prepared remarks, it was related to credit issues with the tenant, that's really all I'm going to comment on. I think your other question on other tenants in the portfolio, actually, we have very few credit issues, if any, at all, of significance. We're really good on that front. This is not a pervasive issue.
Okay. The legal matter that kind of hit G&A this quarter, is it related to this tenant or is it something separate? Is this more ongoing or just one time in the quarter?
Yeah, this is Jeff. It's not related to this tenant. The G&A is related to our defense costs in connection with the Millennium Tower matter in San Francisco.
What should we expect going forward?
We obviously don't know from a legal perspective, the cost. We do have, built into our forecast, some costs assumed for the project for the legal costs. Obviously, we're not going to reveal what those are. We do have some budgeted money for that.
Okay. Just lastly, you guys did kind of use the ATM even though you have a fair amount of sales. Just curious, kind of thought process there, given where the stock's trading relative to consensus on NAVs.
Yeah. We've always said we're going to raise capital in different sources and we're going to keep conservative and take opportunities to raise money both through equity, through disposition, and through debt. We took the opportunity to raise a little bit of capital, $100 million or so, at that price. We felt the projects we're investing in are accretive on that basis, we felt comfortable doing that.
Great. Thank you.
Next question comes from Manny Korchman with Citi. Please go ahead.
Tyler, just to follow up on Craig's question on the G&A. You said you had a budget amount. Has that budget changed between the time you gave guidance in 1Q and your current guidance? I guess differently, how should we think about G&A for this year and for what it's worth next, even though you haven't given guidance there, especially around this legal item?
Yeah. For this year, for the second half, we do expect it to come down a little bit. On a run rate basis per quarter, sort of in the $17.5, $18 million range per quarter for the remainder of the year. It's too early to comment on 2019.
just looking at the larger major expirations that you had in 2018 and 2019. I think you're coming with you're 70% done with the 2018s. What are the prospects for the others, and when should we expect announcements there?
Hey, Manny, it's Rob Paratte. The remaining vacancy we've got in Seattle is actually in Bellevue, and both those spaces are committed, and we're in the final stages of documentation. In San Diego, between Bridgepoint and Del Mar Corporate Center, we have about 65,000 sq ft of activity between the two of them. Again, some in documentation, some in discussions. We feel really good about the activity we've got on both those projects.
Thanks, guys.
The next question comes from Jamie Feldman with Bank of America Merrill Lynch. Please go ahead.
Thank you. Just to follow up on the last question. The 65,000 square feet in San Diego, what does that leave left to lease?
Hold on a second. We've got 114 left at Bridgepoint, if we take the leasing we have there, we probably got two-thirds of it in different stages of activity. At Del Mar Corporate Center, we have 82,000 square feet left, roughly. Again probably over half that is committed in different stages. I'd say with Del Mar Corporate Center, the more One Paseo comes to fruition now that you can see it and drive it and all that sort of thing, it really is causing an uptick in the activity around our portfolio there.
Okay. You said Seattle is pretty much fully leased or will soon be fully leased.
Yeah.
Okay. Tyler, just on the charge, what would it take for you to reverse the charge?
We're really not going to talk about the specifics of what the charge specifically is. Obviously, there's deferred rent, there's some straight line rent, there's TI costs in that number. Obviously, if the tenant shows better credit, then we would evaluate that on a quarterly basis.
Okay. Then I guess just bigger picture, with Dexter and The Academy not leased yet, you started talking about at Oyster Point, you're talking about the office that One Paseo . Just kind of thoughts on both funding needs over the next year and also just your appetite for speculative development risk and how you're thinking about it.
Yeah, this is John. Let me talk about the appetite for speculative. I know I sound like a broken record because every time I've been asked this question, I've had basically the same answer, no matter what the properties were that were under construction or that we were contemplating building over the course of the last 8 years. I don't see us starting big spec projects without having made progress on the existing ones we have, unless they're already leased, which was the case with Hooper and Exchange. We have strong prospects across the portfolio, both on a multi-tenant and full building basis for both of those projects you mentioned. You're going to just see more of the same.
Remember that The Academy we just started the beginning of this year, and it has a couple more years to completion, and 333 Dexter has about 18 months more before we have the shell complete. We feel that in both markets, the rents are going up pretty substantially. We have that tension between when we want to lease them and starting other buildings and how we achieve the best possible financial results with regard to increasing rents. More to come, Jamie.
Okay.
Jamie, on the funding front, on The Exchange and Hooper, we have about $200 million to spend to complete, and on the rest of the projects under construction, about $500 million over the next couple of years. That's $700 million. We obviously have the disposition where we're now nonrefundable on. We have the private placement that we're going to draw down in October. There'll be other funding activity as well. We're going to continue to fund it as we go and knock it out over our skis.
Okay. Then just my last question, what's your appetite for WeWork or other types of co-working tenants at some of these projects?
Yeah, I'll answer that. This is John again. We haven't done any co-work of any magnitude, if at all. We've had many opportunities, whether it was The Exchange or whether it was Hooper or whether it's been properties in other markets. Not saying we won't, just hasn't been our preference. I don't know that it will be our preference.
Okay. All right. Thank you.
The next question comes from John Guinee with Stifel. Please go ahead.
Great. Thanks, Tyler. I think you had mentioned this during the investor day, and then I think maybe John mentioned it earlier today, but you think you can get a 25% increase in your FFO between now and year-end 2020, which is 10 quarters. It's very impressive. It gets you up to $1.10 a quarter to $1.12 a quarter by late 2020. Can you give a little more color in what the main drivers of that might be in as much detail as possible?
Well, if you remember back to the investor day, we put a chart up on the board, which showed the various boxes of that. The stabilized portfolio growth, the new development, both what's under construction, what's being delivered, the 100 and over $1 billion of development coming online. Without going through in excruciating detail on the call, I think I can point you to that deck, which is on our website, but it shows the various components of that, and it's obviously offset by dispositions, and it's obviously everything else being equal, and no other changes to the structure. It basically walks through the various components.
If you do something that significant, make sure you're the first speaker next time, okay? Instead of the fourth hour. Thanks.
The next question comes from Thomas Catherwood with BTIG. Please go ahead.
Thanks. Back to the leasing on the 2018 expirations. A lot of positive commentary about what you've taken down so far. If we look at the midpoint of guidance, it implies roughly $0.86 each quarter in the third, fourth quarter, give or take, which would suggest a roll-down from where we are now. Can you kind of walk through the ins and the outs that you have in the second half of the year, and kind of, obviously, you back-filled the space, but what's the lag between when the expirations happen and when the new leases commence?
Well, it's a good question. Actually, the third-quarter occupancy is going to dip slightly because we have the Delta Dental move-out. We expect that to pop back up in the fourth quarter when Okta is scheduled to move in in that space. There are ins and outs in the timing. Bridgepoint had an expiration in July, General Atomics is taking that space, there's another Bridgepoint expiration in the fourth quarter. There are lots of ins and outs, but the good news is we're backfilling that quickly. I can let Rob talk about how long it usually takes between when someone moves out and when we get someone coming back in.
Yeah. Generally, again, depends on the market, in San Diego and those sub-markets, it's probably anywhere from a minimum of three months to six months, probably, depending on the level of tenant improvement work and other factors with respect to the tenant.
For example, let's take the General Atomics Bridgepoint backfill. It's already signed, is that six months from when Bridgepoint leaves to when you guys start revenue recognition?
We'll go to Jeff again.
Yeah. That one commences in September. I think there's roughly about three months of downtime from when we got the space back to when they're going to fit the space and move in. On the shorter side.
Okay. We get a pick-up then through the back half of the year.
Yes, on that project.
Okay. Then going over to the Brannan Street buildings 301, 333, and 345. Obviously, you've got the termination and re-leasing there. Are you guys putting any incremental capital into those assets? Obviously, other than the purchase price. What's the lag between Dropbox's termination and revenue recognition from GM Cruise?
On the last question, we expect Dropbox to be moving out mid next year, and Cruise will be moving in in late next year. It's still not crystal clear exactly the timing, but could be two, three months of downtime on that lease. In terms of the CapEx, Rob.
It's really just tenant improvements as part of the transaction.
Being that they're all relatively new buildings, or very new buildings, just a standard TI package there, or was it smaller because they're so modern?
The 333 and 345 are the newer buildings, and the TI package is lower. The 301 is older build-out, that's going to have a higher tenant improvement associated with it.
This is John. The TI packages on the newer buildings, and remember, these are long-term leases. The TI package, correct me if I'm wrong, Rob, on the 333, 345 were much less, roughly a third of current market. The TI package on 301, which is a historic build. I don't know if it's historic in the register, but it's an older building, but very cool, which people like. The TI package there was still well below current market. The economics are pretty terrific.
Got it. The last one for me, maybe John, sticking with you. In regards to the Central SoMa plan, it looks like the board of supervisors has begun the review. Do you have a sense of timing on that? If the approval comes through, what are the next steps in the rezoning process?
Yeah. Well, as I said in our investor day, that they were scheduled in July to approve the Central SoMa plan. It's already been approved by the planning department, but that date could be delayed because there were 3 or 4 appeals, and they want to make sure that they respond to those appeals properly to defeat them, and that it could be delayed. They don't have a meeting. They have a recess in August, so it's going to come back in September, and we expect it to be approved then. We don't expect any delays with regard to its implementation. Assuming it is approved in this third quarter, they will have roughly, given the October allocation of 875,000 square feet, they'll have roughly 3 million square feet in the pool by the end of the year.
We would expect the allocations at that time, end of the year or early first quarter.
Got it. Thanks, guys.
The next question comes from John Kim with BMO Capital Markets. Please go ahead.
Thank you. On the reserve that you made this quarter, can you discuss what industry the tenant is in?
No.
I was really asking more about life sciences, because that's been a major push for you, and you have a major development opportunity at Oyster Point, and whether or not this particular incident would impact your decision to move forward with some developments or the timing of it.
The answer to that is no. It has no impact, anything development. It's an existing tenant that's just going through a recap.
Okay. I think, Jeff, in your prepared remarks, you mentioned that leasing in the FIRE industries has picked up. Can you discuss what markets you were referring to, and is this specifically fintech, or is it more broad-based among traditional FIRE tenants?
Yeah, John, this is Rob. Particularly in San Diego, there is an uptick in FIRE category tenants. In the North County, where we are based, that is pretty prevalent.
I think also we are seeing that in San Francisco and have seen that over the past 8 months or so, where if you look at a lot of the composition of the Salesforce Tower leasing, those are expansions of primarily FIRE category tenants. L.A. kind of is centered more in downtown, where we do not have assets in terms of FIRE category. Seattle has actually had some good activity as well in their downtown market from FIRE category.
Okay, great. Thank you.
The next question comes from Daniel Ismail with Green Street Advisors. Please go ahead.
Hey, guys. Good morning. Curious to get your thoughts on Proposition C in San Francisco and its potential impact on the market and your portfolio. Curious to hear any feedback you've received from tenants.
Yeah. This is John. Let me deal with the first one. I haven't heard anything, to my knowledge, from tenants. Rob, correct me if you've heard anything. As of a week or so ago, we hadn't heard any noise from tenants. Secondly, I'll let Tyler talk about the impact. Our reading is based upon lots of conversations with people that were both pro-Prop C and anti-Prop C, both sides of the aisle is the feeling is that this will be ruled unconstitutional and therefore nullified. We can only tell you what we've been hearing. It's interesting when the proponents of Prop C are saying that. With regard to the impact, Tyler, you want to cover that?
Yeah. The impact for 2019, based on our estimates at this point, would be that it would impact our numbers by about a penny and a half a share.
That's helpful. Thanks. Any timing as to, is there any current legal proceedings that are currently ongoing with Prop C?
This is John again. We can find that out. I don't know off the top of my head, you can imagine there's a lot of people that are fighting it.
All right.
I can't tell you about the lawsuits.
Now, you spoke earlier on the rent growth in your markets. Curious to see your thoughts on how concessions have trended year to date.
This is Rob. Anyone else can jump on also. Again, in all the markets we're in, that really is in the landlord's favor. Concessions are not increasing by any means. Tenant improvements typically come up in that sort of discussion. The only increase related to tenant improvements is really driven by the cost of building out space, just labor and materials and that sort of thing. Free rent and the other types of concessions are probably at minimums.
Great. Thanks, guys.
The next question comes from Robert Simone with Evercore ISI. Please go ahead.
Hey, guys. Thanks for taking the question. Just a quick housekeeping item on my end. Some of your peers have begun to share selectively what their views were from the potential impact of when lease accounting changes. I know it's early, obviously, but I was just wondering if you guys had formed any internal views on what that could be next year.
Yeah. We're still working through that. It's a complicated analysis, and it can be impacted by how you structure your compensation and lots of different things. As you know, it's sort of a non-economic change. Right now, if we were to look at it completely without adjusting anything on the compensation front, it could be as much as $0.07 to $0.10 a share. Obviously, that would improve our yields because a lot of that cost is development capitalization, where that would now be expensed, and it would be helping our returns on our development. That's an early number, or that's an early range, so more to come on that.
Thanks, Tyler. Appreciate it.
The next question comes from Steve Sakwa with Evercore ISI. Please go ahead.
Tag team here. I just wanted to see if you guys could discuss maybe a little bit construction costs and what you're seeing. Obviously, it's pretty fluid on tariffs, but I'm just curious, John, as you're looking out at some of these new projects, whether it be Oyster Point or now One Paseo on the office front. How are you guys thinking about construction costs, and how might that impact the returns?
Yeah. Steve, obviously, we don't have a crystal ball. Justin Smart and his group follow this thing about as closely as they do anything. I was talking with him at Link the other day, and he says, "Look, steel is the issue that is the most prevalent, and the implications on cost are somewhere in the neighborhood of 2%-3% when it rattles through the building, because the building's not all made of steel." We've been experiencing, depending upon our markets, San Francisco, Seattle, and so forth, sort of anywhere from 3%-6% increases on certain commodities over the course of the last several years. We bake all that into the performance. As we have seen by the deliveries we've done and by our comments today with regard to that which is under construction, we've adequately provided for potential cost increases.
Will it be a little bit more tricky? Depending on what happens with tariffs and so forth, probably. What are the impacts yield-wise? We've been sort of around that high 7, low 8 on average return, unlevered return on office properties. Could that impact it by 10, 20 basis points? Sure. I don't have any reason to believe it will or it won't. We've also seen rental rate increases, that have sort of outpaced that increase in construction costs. I do think this, that the bigger issue with the question. If I was on your side of the fence, the question I'd be asking is, what's the premium for quality properties and more modern properties versus the older properties that are less desirable?
I think what'll happen is that tenants, I believe the modern, particularly tech, entertainment-type tenant, is gonna be a little insensitive to the parallel increases in rent, because they're gonna go for the right kind of product versus existing product if it doesn't meet their physical criteria. This is gonna play out over time. I think we're in a good shape with regard to the very extensive contingencies and cost structuring that we do in our performance.
Okay, thanks. Then maybe just to circle back to, I guess the 333 Dexter and the Academy. Just in terms of tenant demand and expectations, how do you sort of handicap or kind of lay out the timeline, you think, for getting kind of leasing done at one or both of those projects?
Rob, you want to take that?
Sure. Hi, Steve. Let's talk about Dexter. Just to frame it up, we started construction on Dexter a year ago. We've got about 18 months left for shell and core delivery. There are a number of single-user tenants in that market, but I think what's pretty amazing are the number of good credit, large tenants that aren't full building users that we're seeing. I think what's clear is that Seattle's come onto its own now in terms of where the talent is, the software engineers that companies want, not only in the Bay Area, but other parts of the state. We're seeing an activity level that has increased quite a bit, and it's interesting to me because it's not just Bay Area-focused. I guess more to come is what I'd say.
I don't want to predict the future for you, but we're feeling really good about it. With Academy, as John said, we started that in January. Again, there's such a fundamental change going on in the entertainment industry, and the number of activity levels between full building users and smaller tenants is, again, pretty dynamic. Just a statistic, HBO typically spent, or last year spent $2 billion on content. Netflix spent $8 billion, or is spending $8 billion this year. Now with AT&T, Time Warner taking over HBO, there's something that's going to happen there to close that $6 billion gap, and it's going to happen in Hollywood. There's no question about that. We're seeing a lot of really interesting activity, and it just goes on and on between Disney and other companies in the content and media space.
Okay, thank you.
This concludes our question and answer session. I would like to turn the conference back over to Tyler Rose for any closing remarks.
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