Kilroy Realty Corporation — Q2 2021 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2021. Comparisons are with the corresponding 2020 periods. Amounts are in U.S. dollars; financial statement amounts are generally in millions unless noted.
Business context
Kilroy is a REIT focused on Class A office, life science and mixed-use properties, operating primarily in California, with assets in the Pacific Northwest and Austin. At quarter-end, its stabilized office portfolio included 118 buildings and 14.2 million rentable square feet, with 91.8% occupancy and 93.6% leased. It also had three stabilized residential properties totaling 1,001 units, averaging 70.6% occupancy.
Financial performance and liquidity
| Metric | Q2 2021 | Q2 2020 | Six months 2021 | Six months 2020 |
|---|---|---|---|---|
| Total revenue | $226.0 | $219.4 | $461.6 | $440.8 |
| Net income | $42.9 | $24.4 | $550.3 | $69.8 |
| Net income available to common stockholders | $35.8 | $19.6 | $533.5 | $59.4 |
| Diluted earnings per share | $0.30 | $0.17 | $4.56 | $0.52 |
| Net operating income (NOI) | $161.4 | $157.4 | $331.1 | $315.2 |
| Funds from operations (FFO) | $104.6 | $93.1 | $220.8 | $203.3 |
Q2 revenue increased 3.0% year over year; NOI rose 2.5% and FFO rose 12.4%. Six-month revenue increased 4.7%, NOI 5.0% and FFO 8.6%. Six-month GAAP earnings were unusually elevated by a $457.8 million gain on the sale of an operating property; FFO excludes that gain. Q2 general and administrative expense fell 36.5%, mainly because 2020 included executive and employee severance costs. Interest expense rose 34.7% in Q2 and 44.2% for the six months, primarily reflecting higher average debt balances and lower capitalized interest.
Net cash provided by operations was $216.5 million for the six months, down 3.4% year over year. Investing activities provided $95.3 million, principally reflecting disposition proceeds, offset by development acquisitions and spending. Financing activities used $165.1 million. At June 30, cash and cash equivalents were $519.3 million and restricted cash was $450.5 million, including $431.5 million held by a qualified intermediary for a potential Section 1031 exchange.
Debt totaled $3.952 billion at principal value ($3.923 billion net carrying value); all debt was fixed-rate, with a 3.8% weighted-average stated rate. Debt was 32.5% of total market capitalization. The amended revolving credit facility had $1.1 billion of availability and no borrowings; its maturity was extended to July 2025, with two six-month extension options. The next material debt maturity was January 2023. Management reported compliance with debt covenants.
Material changes and transactions
- In March, Kilroy sold 1800 Owens Street in San Francisco for $1.08 billion gross, recognizing a $457.8 million gain. Net proceeds received were $1.013 billion.
- It acquired two development properties for $622.2 million: a San Diego site for $42.0 million and Indeed Tower in Austin for $580.2 million. Indeed Tower was 57% leased at quarter-end and is expected to stabilize in Q4 2022.
- Quarter-end stabilized office occupancy was 91.8%, versus 91.2% at December 31, 2020. Average Q2 office occupancy was 91.7%, compared with 92.8% a year earlier; residential average occupancy was 71.9%, compared with 85.0%.
- Approximately 10.3% of stabilized office space was available for sublease, primarily in the San Francisco Bay Area. About 2.6% and 6.0% of occupied portfolio space was scheduled to expire during the remainder of 2021 and in 2022, respectively.
Outlook, risks and unusual items
The filing provides no specific company-wide revenue, earnings or FFO guidance. Management expects to pursue development prudently, favoring strategic locations and, generally, pre-leasing; timing and investment decisions remain subject to market conditions. Two projects were under construction, with estimated total investment of approximately $1.1 billion; four projects were in the tenant-improvement phase, with estimated total investment of approximately $1.8 billion. Six future development sites represented an estimated $5.0–$7.0 billion of potential investment, subject to entitlements and market conditions.
Management reported collecting approximately 97% of Q2 gross rent billings, consistent with 2020 collections. It cautioned that COVID-19 could continue to affect tenant operations, leasing timing, occupancy, rent collection, construction costs and capital markets. Other stated risks include tenant defaults or non-renewals, weaker office demand, competition and sublease supply, development delays or cost overruns, financing availability, property-value declines and environmental obligations.
Environmental remediation liabilities of approximately $77.6 million were accrued for certain development sites; additional costs may arise but could not be reasonably estimated. The company disclosed a dispute with DIRECTV over claimed lease contraction rights and said it would vigorously defend the litigation; it did not consider the legal proceedings disclosed at quarter-end likely to have a material adverse effect. The company declared a regular $0.50 quarterly dividend per share; payment was made July 14, 2021. Management noted a special dividend may be required if it cannot complete suitable 1031 exchanges to defer taxable gains from dispositions.
Subsequent to quarter-end, on July 8, Kilroy acquired the land underlying its Bellevue property for $47.0 million.
Key facts for investors to verify
- How much of the six-month earnings increase reflects the one-time property-sale gain, and how are recurring NOI and FFO trends developing?
- Whether the $431.5 million of restricted sale proceeds is applied to qualifying replacement property within applicable 1031 deadlines, or instead leads to tax or distribution implications.
- Leasing progress, stabilization timing and remaining capital requirements for Indeed Tower and other development projects, especially Oyster Point Phases 1 and 2.
- Office occupancy, sublease availability, rent collections and renewal outcomes as tenants respond to post-pandemic workplace changes.
- Potential changes in the $77.6 million environmental remediation estimate, and developments in the DIRECTV litigation.
- Future dividend coverage and capital needs given development commitments, debt maturities and the REIT distribution requirement.