Morningstar | Long-Term Thesis Remains Intact as Kilroy Realty Reports Strong 3Q Results
Kilroy Realty’s third-quarter results were slightly better than our expectations, but we do not see any reason to materially change our $82 fair value estimate and our no-moat rating for the firm. Kilroy’s comparably large West Coast exposure continues to show favorable market dynamics, which led the company to beat our funds from operations expectations by two cents. The driving force behind the earnings beat is higher than expected revenues following strong growth in cash rents on leases executed, 16% cash rent growth versus our long-term expectation of 11.5%. Kilroy’s revenue beat was partially offset by weaker than anticipated occupancy. That said, we think the slightly weaker occupancy is short-term in nature as the company just signed a large lease with Facebook. We believe this lease combined with the strong releasing spreads in the third quarter demonstrate that Kilroy offers some of the highest-quality office space in the West Coast market.Fundamentals in West Coast markets continue to show strong growth, which gives us confidence in our five year 7% FFO compound annual growth rate. California and Seattle’s technology markets continue to drive job growth and demand high-quality office properties. San Francisco’s economy, in particular, is displaying strength with 98% occupancy. We are especially excited about Kilroy’s San Francisco portfolio because management indicated that rents remain 34% below market, which we believe will feed NOI growth in coming years as the below-market leases are repriced. One factor that concerns us is that there are three major leases that are larger than ninety thousand square feet coming up for renewal in 2020; if Kilroy is not able to renew these leases, it may be challenging to find another tenant large enough to fill the offices. Overall, we see the strong current results as reassurance after a tenant credit issue negatively impacted FFO during the second quarter.
Kilroy Realty is a self-administered real estate investment trust engaged in premier office and mixed-use submarkets along the West Coast. The company owns, develops, acquires and manages real estate assets, consisting primarily of class A properties in the coastal regions of Greater Los Angeles, San Diego County, the San Francisco Bay Area and Greater Seattle. The company owns its interests in all of its real estate assets through Kilroy Realty, L.P. (Operating Partnership) and Kilroy Realty Finance Partnership, L.P. and conducts substantially all of its operations through the Operating Partnership. The company's stabilized portfolio of operating properties include stabilized office and residential properties.
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