Kilroy Realty Corporation and Kilroy Realty, L.P. — Q3 2023 Form 10-Q
Reporting period: Three and nine months ended September 30, 2023. Financial amounts below are in U.S. dollars; amounts converted from the filing’s thousands are shown in millions. The filing presents the Company and its Operating Partnership as an interrelated consolidated business.
Business context
Kilroy is a REIT focused on office, life science and mixed-use properties, primarily in California, with properties also in Washington and Texas. At quarter-end, its stabilized office portfolio comprised 120 buildings and 16.3 million rentable square feet, with 86.2% economic occupancy; its three stabilized residential properties had 1,001 units and 92.9% average occupancy.
Financial and operating performance
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Total revenue | $283.6m | $276.0m | $860.7m | $812.6m |
| Net income | $58.7m | $86.7m | $185.2m | $200.0m |
| Net income available to common stockholders | $52.8m | $79.8m | $165.0m | $180.0m |
| Diluted earnings per share | $0.45 | $0.68 | $1.40 | $1.53 |
| Net operating income (NOI), as defined by the company | $193.4m | $194.7m | $600.4m | $581.0m |
| Funds From Operations (FFO) | $134.0m | $139.7m | $421.9m | $416.8m |
| Net cash from operating activities | — | $492.4m | $484.2m |
Q3 revenue increased 2.8%, while common-stockholder net income declined 33.8%. NOI declined 0.7% for the quarter but rose 3.3% year to date. Same-store NOI fell 5.0% in Q3 and 1.2% year to date. FFO decreased 4.0% in Q3 and increased 1.2% year to date. The filing does not provide a conventional profit-margin measure.
Rental income was $280.7m in Q3, up from $272.5m. Average stabilized portfolio occupancy for the quarter was 86.1%, compared with 91.1% a year earlier. For second-generation leases commenced, reported GAAP rent changes were +6.9% in Q3, while cash rent changes were -6.2%; year to date they were +13.4% and -0.5%, respectively.
Debt, liquidity and capital
- At September 30, total debt was $4.970bn gross principal and $4.935bn net carrying value. Debt was 57.1% of total market capitalization, as calculated by the company.
- Cash and cash equivalents were $618.8m; marketable securities included $252.8m of short-term certificates of deposit, intended to be held to maturity in January and April 2024. The revolving credit facility had $1.1bn of remaining capacity and no borrowings.
- The $520m unsecured term loan was fully drawn, bore 6.37% interest and matures October 3, 2024, with two 12-month extension options. The $1.1bn revolver bore 6.31% and matures July 31, 2025, subject to extension options.
- In July, the company added a $375m mortgage loan secured by the One Paseo mixed-use campus. It bears 5.90% interest, is interest-only, and matures in August 2034. The company also repurchased $14.3m of 3.45% notes due December 2024, leaving $410.7m outstanding.
- Debt maturities total $936.7m in 2024, including the term loan and senior notes. Fixed-rate debt was 89.5% of total debt; variable-rate debt was 10.5%. The company reported compliance with all debt covenants.
- For the first nine months, operating cash flow was $492.4m, investing cash outflow $660.5m and financing cash inflow $439.5m. Investing outflows included $338.8m for development and redevelopment and $252.8m for certificates of deposit. Dividends and distributions paid were $191.5m.
Material changes and unusual items
- Q3 interest expense rose 49.3% to $29.8m; nine-month interest expense rose 34.8% to $81.9m. Management attributed the increases principally to higher average debt and interest rates. Weighted-average interest rates were 4.16% for Q3 and 4.10% year to date, versus 3.87% in both 2022 periods.
- Q3 2022 included a $17.3m gain on sale of a depreciable property; there was no comparable gain in 2023. This contributed to the year-over-year decline in reported net income.
- Same-store Q3 NOI was pressured by lower revenue from lease expirations and higher property expenses, including insurance. Development-property NOI increased, partly as Indeed Tower lease revenue commenced.
- Share-based compensation included $21.2m year to date related to accelerated vesting associated with the CEO’s announced retirement, effective December 31, 2023. The filing reports approximately $28.5m of unrecognized compensation cost at quarter-end.
Outlook, risks and contingencies
- No specific earnings or FFO guidance is provided. Management said available liquidity, operating cash flow, borrowing capacity and capital-recycling sources are expected to cover projected liquidity needs over the next 12 months, while noting there can be no assurance of continued access to capital.
- Management expects $61m–$125m of remaining 2023 spending on current development and redevelopment projects. Remaining investment for the six identified projects was estimated at $489m. Eight future development sites represent a potential investment of approximately $8bn–$9bn, subject to entitlements, market conditions and other factors.
- The company cited reduced office demand, remote and hybrid work, sublease competition, tenant defaults, lease rollover, higher interest and construction costs, inflation, financing-market volatility, property-value declines, and development delays as risks. It also added discussion of labor disputes and entertainment-industry strikes that could affect tenants and rent collection.
- Commitments for contracts and executed leases were approximately $396.5m, excluding ground-lease commitments. Accrued environmental remediation liabilities were approximately $77.8m. The company reported no legal proceedings it believed would have a material adverse effect.
- Stabilized office space available for sublease was approximately 1.5 million square feet, or 9.0% of the portfolio. The company said weighted-average cash rents were about 5% below current average market rents, but cautioned that future leasing and rental rates are uncertain.
Important facts for investors to verify
- Leasing, occupancy and sublease trends by market, especially San Francisco Bay Area and Greater Seattle, and upcoming lease expirations.
- Refinancing or extension plans for the $520m term loan and the $410.7m of notes due in 2024, along with borrowing costs and covenant headroom.
- Development project leasing, completion timing, remaining costs and exposure to construction inflation or delays.
- Whether operating cash flow can sustain dividends and fund capital requirements; the quarterly dividend was $0.54 per share, and future distributions remain at Board discretion.
- Progress and ultimate cost of environmental remediation, and any changes in tenant creditworthiness, labor disruptions or collectability assumptions.