Kilroy Realty Corporation — FY 2017 Form 10-K
Reporting period: Year ended December 31, 2017. This annual filing covers Kilroy Realty Corporation, a REIT, and its consolidated operating partnership. The company owns, develops, acquires and manages primarily Class A office and mixed-use properties in coastal California and Greater Seattle.
Business and portfolio
- At year-end, the stabilized portfolio comprised 101 office buildings and 13.72 million rentable square feet, 95.2% occupied and 96.9% leased. Office occupancy was 96.0% at year-end 2016.
- The company also operated one 200-unit residential property, with 70.2% average occupancy in 2017.
- Four projects were under construction, representing approximately 1.8 million square feet of office space, 96,000 square feet of retail and 237 residential units. Estimated total investment was approximately $1.5 billion.
- Portfolio and tenant exposure is concentrated in California and Greater Seattle. Technology tenants accounted for 43% of annualized base rent; the 15 largest tenants accounted for 40.3%.
Financial and operating metrics
| Metric | FY 2017 | FY 2016 | Change |
|---|---|---|---|
| Revenue | $719.0 million | $642.6 million | +11.9% |
| Net income | $180.6 million | $303.8 million | -40.5% |
| Net income available to common stockholders | $151.2 million; $1.52 diluted EPS | $280.5 million; $2.97 diluted EPS | Lower mainly due to reduced property-sale gains |
| Net operating income (non-GAAP supplemental measure) | $513.0 million | $470.0 million | +9.1% |
| Funds from Operations (FFO; non-GAAP) | $346.8 million | $333.7 million | +3.9% |
| Cash provided by operating activities | $347.0 million | $345.1 million | +0.6% |
| Cash used in investing activities | $359.1 million | $579.4 million | Outflow decreased |
| Cash from (used in) financing activities | $(171.2) million | $427.3 million | Shifted to outflow |
Property NOI growth reflected development projects entering the stabilized portfolio and acquisitions, partly offset by dispositions and higher property expenses. NOI is a company-defined supplemental measure, and FFO excludes real-estate depreciation and certain property-sale gains; neither replaces GAAP results.
- Margins and costs: Reported property expenses were $130.0 million, real estate taxes $66.4 million, depreciation and amortization $245.9 million, and interest expense $66.0 million. The filing does not present a single operating-margin measure as a headline metric.
- Debt and liquidity: Gross principal debt was approximately $2.364 billion ($2.347 billion net carrying value); debt was 23.9% of market capitalization. All year-end debt was fixed-rate. Cash and cash equivalents were $57.6 million, plus $9.1 million restricted cash. The $750 million revolving facility and $150 million term facility were undrawn at year-end; the company reported covenant compliance.
- Capital returns: Common dividends declared were $1.65 per share for 2017, versus $3.375 in 2016, which included a $1.90 special dividend. The regular quarterly dividend reached $0.425 per share during 2017. The Series G and H preferred stock were redeemed for $200 million in total.
Material changes and notable items
- Revenue rose 11.9%, while GAAP net income fell 40.5%. Property-sale gains declined to $39.5 million from $164.3 million in 2016, a key reason the earnings comparison weakened.
- Same-store NOI increased 1.1%; total NOI growth was supported substantially by development and acquisition properties. Year-end stabilized office occupancy declined 0.8 percentage point.
- The company completed Columbia Square Phase 2 and began construction on 333 Dexter. In 2017 it sold 11 office buildings and one land parcel for gross proceeds of $186.6 million, compared with $330.7 million of property and land sale proceeds reported for 2016.
- Financing actions included issuing common equity for $308.8 million net proceeds, issuing $675 million aggregate principal of notes, and redeeming $325 million of 4.8% notes early. The early redemption produced a $5.3 million loss. The company also issued $250 million of private-placement notes and expanded its revolving credit facility to $750 million, with maturities extended to 2022.
- In January 2018, the company drew $75 million on its term facility and acquired three lab buildings totaling 146,000 square feet for approximately $111 million.
Outlook, risks and contingencies
- Management emphasized long-term growth in NOI and FFO through leasing, development and selective acquisitions, supported by capital recycling. It anticipated potential 2018 disposition proceeds of $250–$750 million, with a $500 million midpoint, subject to market conditions. It also estimated up to $100–$300 million of potential development starts during 2018. The supplied filing text does not provide clear quantitative 2018 earnings or FFO guidance.
- Management reported 2.0 million square feet of stabilized-portfolio leases executed in 2017, with GAAP rents up 25.0% and cash rents up 11.2%. However, 9.0% of leased square footage was scheduled to expire in 2018 and 11.9% in 2019; renewal, occupancy and rental-rate outcomes remain uncertain.
- Tenant concentration, especially in technology, and regional concentration expose the company to industry and local-market downturns. Other material risks include development costs, construction and leasing execution, access to capital, interest rates, earthquakes and other natural disasters, regulation, and environmental liabilities.
- Environmental remediation liabilities accrued were $28.3 million at year-end; additional costs could arise and were not reasonably estimable for certain pre-development sites. The company also disclosed cross-claims against its entities related to development of nearby 350 Mission Street; it disputes the allegations and intends to defend them. Management said it knew of no litigation expected to have a material adverse effect.
- The company noted that adopting the new lease accounting standard in 2019 was expected to materially affect reported financial statements, including recognition of ground-lease assets and liabilities and expensing certain leasing costs previously capitalized.
- Deloitte issued unqualified opinions on the financial statements and internal controls; management concluded disclosure controls and internal control over financial reporting were effective.
Most important facts for investors to verify
- Whether reported NOI and FFO growth translates into durable cash generation after leasing costs, tenant improvements, capital expenditures and development spending.
- Lease rollover exposure and tenant retention, particularly the 2018–2019 expirations and the large tenant concentrations.
- Delivery timing, total costs, leasing and stabilization of the four active development projects, including funding for remaining commitments.
- Progress and actual proceeds from the planned disposition program, and whether proceeds can be reinvested or used to manage debt without adverse tax consequences.
- Debt maturities, covenant headroom, refinancing terms and the effect of future borrowing or interest-rate changes on distributions.
- Potential additional environmental remediation costs, the 350 Mission Street litigation claims, and the financial and reporting impact of lease-accounting changes.