Kilroy Realty Corporation (KRC) — Q2 2023 Form 10-Q
Business context and reporting period. Unaudited results cover the three and six months ended June 30, 2023, compared with the corresponding 2022 periods. Kilroy is a REIT focused on office, life science and mixed-use properties, primarily in California, with assets in Washington and Texas. Its stabilized portfolio included 119 office and life science properties totaling 16.2 million rentable square feet and 1,001 residential units. The combined filing reports the Company and its operating partnership, which have substantially the same consolidated operations.
Key financial metrics
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Total revenue | $284.3 million | $271.2 million | $577.1 million | $536.7 million |
| Net income | $61.3 million | $54.0 million | $126.5 million | $113.4 million |
| Net income available to common stockholders | $55.6 million; $0.47/share | $47.1 million; $0.40/share | $112.2 million; $0.95/share | $100.2 million; $0.85/share |
| Net operating income (NOI; non-GAAP) | $198.6 million | $194.0 million | $407.0 million | $386.3 million |
| Funds from operations (FFO; non-GAAP) | $141.9 million | $139.4 million | $287.8 million | $277.1 million |
| Interest expense | $26.4 million | $20.1 million | $52.1 million | $40.7 million |
Cash flow and liquidity. For the first six months, operating cash flow was $283.6 million versus $278.9 million; investing cash use was $259.4 million versus $312.7 million; financing cash use was $9.7 million versus $170.3 million. Cash and cash equivalents were $361.9 million at June 30, 2023, up from $347.4 million at year-end 2022. The company reported $1.1 billion available under its revolver and $170 million available under its term loan facility.
Debt and balance sheet. Gross debt principal was $4.44 billion ($4.41 billion net carrying value); total debt equaled 55.5% of total market capitalization. At June 30, 92.1% of debt was fixed-rate and 7.9% variable-rate; reported weighted average stated rate was 3.9%. The revolver had no borrowings; the term loan had $350 million outstanding at 6.17%. The company was in compliance with its debt covenants. June 30 debt maturities include $781.0 million in 2024, including the term loan, which has two extension options.
Margins and portfolio operations. Q2 total NOI rose 2.4%, while same-store NOI fell 2.3%; for the first half, total NOI rose 5.4% and same-store NOI rose 0.6%. Stabilized office economic occupancy was 86.6% at June 30, down from 89.6% at March 31 and 91.6% at December 31, 2022. Q2 average stabilized occupancy was 87.4%, versus 91.5% a year earlier. These occupancy figures and NOI are supplemental measures as defined by the company.
Material changes versus prior periods
- Q2 revenue grew 4.8% year over year, but property and related expenses rose faster, increasing 11.0%; same-store NOI declined as expense growth outweighed modest revenue growth.
- Development-property NOI increased, with Indeed Tower contributing $5.6 million to Q2 NOI growth, primarily from a full quarter of revenue recognition on leased space.
- Higher average debt balances and interest rates drove Q2 interest expense up 31.1%; first-half interest expense rose 27.8%.
- First-half FFO increased 3.9%, while common-stockholder net income increased 11.9%.
- First-half development and redevelopment spending was $214.3 million. No acquisitions were completed in the period, compared with $40.0 million of acquisition spending in the 2022 first half.
Outlook, commentary, risks and unusual items
- Outlook and capital plans: Management anticipated raising up to $200 million through dispositions during the remainder of 2023, subject to market conditions and transaction execution. The future development pipeline comprised eight sites with an estimated $8–9 billion total investment potential, conditional on entitlements and market conditions. No specific company-wide revenue, earnings or FFO guidance is provided in the supplied filing text.
- Development commitments: Eight active development/redevelopment projects had $583 million of estimated remaining investment; $141–185 million was expected to be spent in the remainder of 2023. The company cautioned that costs and timing may change, including due to inflation, construction conditions, leasing and delays.
- Leasing and demand: Management cited increased physical occupancy and some large employers’ return-to-office mandates, but said economic uncertainty and hybrid/remote work continued to affect leasing timing and volume. About 2.2 million square feet, or 13.4% of the stabilized portfolio, was available; 1.5 million square feet, or 9.4%, was available for sublease, primarily in the San Francisco Bay Area. The filing estimates portfolio cash rents were 5–10% below current market rents, but does not assure space can be leased at those rates.
- Tenant and concentration exposures: The 15 largest tenants accounted for 47.1% of annualized base rent. Sorrento Therapeutics entered Chapter 11 and rejected its lease at a property being redeveloped for life science use; Kilroy said it was continuing the build-out to seek another tenant.
- Post-quarter financing: On July 20, subsidiaries entered into a $375 million mortgage loan secured by the One Paseo campus. It bears 5.90% interest, is interest-only, and matures August 10, 2034; it is generally non-recourse, subject to specified exceptions.
- Other notable items: The CEO announced retirement effective December 31, 2023. Accelerated equity-award vesting generated $13.2 million of compensation expense in the first half. Environmental remediation liabilities were $76.3 million; commitments for operating, development and redevelopment properties were approximately $497.5 million, excluding ground leases. The company identified potential risks from office demand, tenant credit, interest rates, inflation, refinancing and labor disruptions, including entertainment-industry strikes. It reported no legal proceedings believed likely to have a material adverse effect.
Important facts for investors to verify
- Whether occupancy and leasing stabilize, particularly in Greater Seattle, where reported occupancy fell to 83.4% from 95.3% in the prior quarter, and in the San Francisco Bay Area where sublease availability is concentrated.
- Lease renewals, new leasing, tenant credit and expirations: 4.2% of occupied space was scheduled to expire in the remainder of 2023 and 7.8% in 2024 as of June 30.
- Execution and funding of the development program, including remaining costs, leasing progress at Indeed Tower and Oyster Point Phase 2, and construction-cost or schedule changes.
- Refinancing plans for 2024 maturities, the cost and terms of the post-quarter One Paseo mortgage, and the effect of floating-rate debt and higher interest costs on cash flow.
- Whether anticipated dispositions, including the stated potential of up to $200 million in the remainder of 2023, are completed and at acceptable prices.
- The sustainability of the $0.54 quarterly dividend relative to operating cash flow, development spending, debt service and REIT distribution requirements.