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Morningstar | Changing Office Dynamics on West Coast Support High Uncertainty For Kilroy Realty Corp

Kilroy Realty is one of the most strategically disciplined office real estate investment trusts we cover. It measures its growth not by the size of its portfolio, but by a variety of other value-creating factors that we’ve seen come to light in recent years. Since 2010, portfolio size has been relatively flat at a little over 14 million square feet; however, occupancy has grown to 94% from 89%, with funds from operations rising almost 70% to $3.40 per share from $2.05. A large driver of the company’s increased efficiency and value creation has been its capital recycling program, which has seemingly timed the market well through the ups and downs preceding and following the recession. Unlike many other firms we cover, Kilroy has no exposure to Manhattan or even the East Coast. Instead, it has been capitalizing on the explosion of tech-based demand for office space in recent years. While it started its focus in Southern California, it soon expanded north to meet growth markets such as San Francisco and, most recently, Seattle. Near-term catalysts will include progress on The Exchange, the 750,000-square-foot property in San Francisco's Mission Bay. Kilroy has leased 100% of the space to Dropbox, maintaining its ability to attract high-quality West Coast tenants. We believe Kilroy will face some near-term headwinds, considering that one third of its office space is up for expiration in the next four years. Much of this space is concentrated in markets with significant supply under construction, such as San Francisco and Seattle. We see a strong West Coast job market pushing rents higher for Kilroy. Numerous unfilled tech positions remain, and we have confidence that the company will continue to attract high-quality names to its Class A properties.