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Kilroy focuses on long-term strategy as net income, occupancies drop

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Los Angeles-based Kilroy Realty, which owns 5.25 million square feet of mostly office space in San Diego County, saw a significant drop in its net income in 2013's first quarter, but is focused on a longer-term investment strategy.

For the first quarter ended March 31, Kilroy (NYSE: KRC) posted $2.38 million in net income on $117.49 million in revenues, compared to $78.5 million in net income on $92.39 million in revenues for the like period last year.

Tyler Rose, Kilroy's chief financial officer, said the numbers to focus on are the funds from operations (FFO), defined as net income plus depreciation or amortization, less gains from real property sales.

By this accounting, a standard for real estate investment trusts (REITs), Kilroy Realty reported $49.1 million in FFO or 62 cents per share in the first quarter of 2013, compared to $33 million in FFO or 49 cents per share for the like period a year earlier.

Kilroy saw its San Diego office occupancy decline somewhat from 91.7 percent in March 2012 to 87.2 percent in March 2013, but it also saw a slight increase in the portfolio.

Rose said Avnet Technology Solutions vacated roughly 100,000 square feet in the company’s local headquarters complex in Del Mar Heights during the quarter, but the space has since been filled by Volcano Corp. (Nasdaq: VOLC), which specializes in vascular ultrasound devices.

Kilroy’s San Diego County stabilized portfolio had approximately 670,700 rentable square feet available as of March 31.

The firm reported 183,400 square feet worth of leases are set to expire in San Diego County this year, and 461,900 rentable square feet are scheduled to expire in 2014.

While Kilroy owns more property in San Diego County than in any other submarket, it has been shifting more of its focus to the Seattle and San Francisco markets, where it has been accelerating its acquisitions.

For example, the company acquired a two-building, approximately 321,000-square-foot office property in the South Lake Union submarket of Seattle for approximately $170 million, including the assumption of approximately $84 million in debt.

“As our first-quarter activity demonstrates, we remain focused on building the long-term value of our portfolio through both opportunistic acquisitions and well-executed development, while maintaining a strong balance sheet,” said John Kilroy Jr., the company's president and CEO, in a statement.

Although Kilroy may have sharply curtailed its San Diego acquisition activity, the REIT has at least a decade’s worth of plans entailing millions of square feet of planned office and mixed-use development that should keep the company active in San Diego for many years to come.

One long-range opportunity is a 1.7 million-square-foot development known as One Paseo that would be built on a 23-acre site, at the corner of Del Heights Road and El Camino Real, in the Carmel Valley area.

Now being processed by the city, that plan calls for 500,000 square feet of office space, 270,000 square feet of retail, a 130 to 150-room hotel, 608 multifamily units and enough parking for 4,000 vehicles.

The One Paseo development may be the largest Kilroy project in the works here, but there are no fewer than six others in the pipeline, spread from Sorrento Mesa to Carlsbad.

One of these properties is Pacific Corporate Center Lot 8 in Sorrento Mesa where a 170,000-square-foot building is planned.

Rose said this could be the first speculative office development of any size in the county in years, though Kilroy would almost certainly try to get it substantially pre-leased prior to construction.

Kilroy could also pull the trigger on one or more of the next buildings in the Sorrento Gateway complex.

The CoStar Group (Nasdaq: CSGP) identifies one of these as being a proposed 82,063-square-foot building in the 4900 block of Director’s Place in Sorrento Mesa, but made no reference to the other lot identified by Kilroy at Sorrento Gateway.

Other office projects being proposed by Kilroy include a plan on the site of the Rancho Bernardo Corporate Center that is now industrial, four development sites in the Carlsbad Oaks Business Park, and the next two phases of Santa Fe Summit — Intuit occupies the first phase — along state Route 56 near Rancho Penasquitos.

Rose said market conditions will determine which location and building happen first.

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