Business context and reporting period
Kilroy Realty Corporation is a self-administered REIT focused on Class A office properties in coastal California and greater Seattle. This combined Form 10-K covers the fiscal year ended December 31, 2015; the Corporation owns approximately 98.1% of Kilroy Realty, L.P., which conducts substantially all operations.
At year-end, the stabilized portfolio comprised 101 buildings, 13.0 million rentable square feet, 517 tenants and 94.8% occupancy. The filing also reports unaudited fourth-quarter results.
Financial and operating performance
- Revenue: $581.3 million for 2015, up 11.4% from $521.7 million. Rental income was $525.4 million; tenant reimbursements were $53.8 million.
- Profit: Net income available to common stockholders was $220.8 million, or $2.44 basic and $2.42 diluted per share, versus $167.0 million, or $1.99 basic and $1.95 diluted, in 2014. Results included $110.0 million of gains on sales of depreciable properties and $17.1 million of net gains on land sales. FFO, a non-GAAP measure, was $316.6 million versus $250.7 million.
- Fourth quarter: Revenue was $147.4 million and net income available to common stockholders was $25.3 million, or $0.27 per basic and diluted share. The filing does not provide a directly comparable fourth-quarter presentation unaffected by discontinued-operations accounting changes.
- NOI and leasing: Net operating income increased 13.2% to $422.0 million. Same-store NOI rose 2.6%; year-end portfolio occupancy increased to 94.8% from 94.4%. Leases commenced during 2015 showed 32.9% GAAP rent growth and 20.5% cash rent growth, as reported for the applicable lease cohort.
- Cash flow: Operating cash flow was $272.0 million, up 10.9%. Investing cash outflow was $262.8 million and financing cash inflow was $23.5 million. Year-end cash and cash equivalents were $56.5 million.
- Debt and liquidity: Debt carrying value was $2.24 billion, down from $2.47 billion; aggregate principal was approximately $2.24 billion. Debt was 26.7% of market capitalization, or 29.1% including preferred equity. 91.6% of debt was fixed-rate. The $600 million revolving facility had no borrowings at year-end and matured in July 2019. The next stated debt maturity was $64.3 million of secured debt in February 2017. The company reported covenant compliance.
- Distributions: Common dividends remained $1.40 per share for the year ($0.35 quarterly); preferred dividends were $13.25 million for the year.
Material changes versus the prior comparable period
- Revenue increased 11.4%, NOI rose 13.2%, and FFO increased 26.3% year over year. Management attributed NOI growth mainly to developments moving into stabilized operations, higher same-store rents and occupancy, and acquisitions completed in 2014.
- GAAP income comparisons are materially affected by property-sale gains and a presentation change: adoption of ASU 2014-08 meant 2015 property sales were reported in continuing operations, while prior-year sales were generally shown in discontinued operations. Therefore, continuing-operations and net-income comparisons are not fully like-for-like.
- Debt declined by approximately $230.9 million in carrying value. The company issued $400 million of 4.375% notes due 2025, repaid $325 million of notes at maturity and repaid $150.1 million of secured debt. It also raised $387.8 million net from common equity issuance, including a registered direct placement and ATM sales.
- Occupancy improved overall, but performance differed by market: San Diego occupancy declined to 89.6% from 90.9%, and Greater Seattle fell to 95.1% from 98.1%; San Francisco Bay Area occupancy rose to 98.1% from 97.3%.
Outlook, management commentary, risks and unusual items
- Management cited strong leasing, disciplined development execution, capital recycling and a strengthened balance sheet, including upgrades to Baa2 by Moody’s and BBB by S&P. It stated a goal of sustainable long-term NOI and FFO growth; the filing does not provide specific earnings or FFO guidance.
- Five projects were under construction, totaling approximately 1.91 million square feet and an estimated $1.2 billion investment. About $774.7 million had been incurred and $329 million remained committed at year-end. Management estimated an additional $0–$250 million could be spent on these and other projects in 2016, depending on conditions.
- Management anticipated 2016 asset-sale proceeds of approximately $300–$600 million, including $266.8 million from properties and land sold in January 2016. This is an expectation, not a commitment; timing and proceeds depend on market conditions and tax-deferred exchange availability.
- Management estimated $25–$50 million of 2016 capital improvements, tenant improvements and leasing costs for stabilized properties, in addition to existing contractual commitments. Common distributions remain subject to Board discretion and REIT requirements.
- Key risks include geographic concentration in California and Seattle; tenant and industry concentration (technology accounted for 37% of annualized base rent); dependence on lease renewals and re-leasing; 5.2% of stabilized space vacant; and lease expirations representing 5.8% and 10.4% of leased square feet in 2016 and 2017, respectively. The 15 largest tenants generated 36.9% of annualized base rent.
- Other risks include development cost, entitlement, completion and lease-up uncertainty; interest-rate and refinancing exposure; earthquake and environmental liabilities; ground-lease restrictions; and REIT qualification and distribution requirements. Accrued environmental remediation liabilities were $20.9 million; possible additional costs were not reasonably estimable. Management reported no litigation expected to have a material adverse effect.
- Auditors issued unqualified opinions on the financial statements and internal controls; management concluded disclosure controls and internal control over financial reporting were effective.
Important facts for investors to verify
- Separate recurring operating performance from the $127.1 million of reported property and land sale gains, and account for ASU 2014-08’s effect on year-over-year presentation.
- Confirm whether development projects meet budget, completion and lease-up assumptions, especially the unleased Exchange on 16th project and Columbia Square Phase 2, which was 58% pre-leased.
- Track tenant concentration, occupancy and rent spreads as major 2016–2017 leases expire, particularly in San Diego and Seattle.
- Review execution of planned 2016 dispositions and reinvestment plans, including the implications of unavailable or unsuccessful Section 1031 exchanges.
- Assess liquidity, debt maturities, variable-rate exposure, covenant headroom and the funding needed for development, leasing costs and distributions.
- Evaluate FFO alongside GAAP results and the recurring capital and leasing expenditures that FFO excludes.